1. S˜ao Paolo Foods is a Brazilian producer of breads and other baked goods. Ove

Question

1. S˜ao Paolo Foods is a Brazilian producer of breads and other baked goods.
Over the past year, protability has been strong and the share price has risen
from R$15 per share to R$25 per share. The company has 20 million shares
outstanding. The company's borrowing is conservative; the company has
only R$100 million in debt. The debt trades at a yield to maturity 50 basis
points above Brazilian risk-free bonds. S˜ao Paolo Foods has a market beta
of 0.7. If the Brazilian risk-free rate is 7 percent, the market risk premium is
5 percent, and the marginal tax rate is 30 percent, what is S˜ao Paolo's cost of
capital?

Explanation / Answer

After tax Cost of Debt (Kd) = (7.0 + 0.50)(1-0.3) = 5.25%

Cost of equity as per CAPM = Risk free rate + Beta*Market risk premium= 7 + 0.7*5 = 10.5%

Market Value Weights of Debt and Equity:

MV of Debt                 = $100 m      16.67%

MV of Equity (20*25) = $500 m      83.33%

Total                          $600 m

WACC:

WACC = Cost of debt*Weight of Debt + Cost of Equity*Weight of equity = 5.25*0.1667 + 10.5*0.8333 = 9.62%

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