Question

How do you calculate the cost of debt of each division(Food processing and instruments) for chestnut using proxy companies in same industry.

Exhibit 14.4  Finiancial Data for Industry Comparables, December 2013 (dollar figures in millions)
				S&P Bond		Total Equity	Total Equity
			Equity Beta	Rating	Total Debt	(Book value)	(Market Value)
Chestnut Foods			0.9	A-	461	1,544	1,840
Food Processing Industry
Boulder Brands			0.55	B+	298	355	958
Campbell Soups			0.6	BBB+	4,832	1,349	13,223
ConAgra Foods			0.7	BBB-	9,590	5,472	13,805
Diamond Foods			0.75	B-	593	167	578
Flower Foods			0.5	BBB-	923	1,076	4,429
General Mills			0.55	BBB+	8,645	6,633	31,245
Hormel Foods			0.65	A	250	3,311	11,759
Kellogg			0.6	BBB+	7,358	3,545	21,841
J. M. Smucker			0.7	BBB+	2,241	5,168	10,904
Tyson Foods			0.8	BBB	1,942	6,285	11,469
Average
Instruments Industry
Badger Meter			1.06	BBB-	89	197	723
Dresser-Rand			1.4	BB	1,287	1,297	4,549
Flowserve			1.3	BBB-	1,200	1,870	10,767
Honeywell			1.25	A	8,829	17,467	74,330
Idex			1.15	BBB	774	1,573	5,933
Measurement Specialties			1.35	BBB*	129	331	944
Mettler-Toledo			1.1	A*	413	935	7,154
Wendell Instruments			0.52	NA	0	98	230

Exhibit 14.3   Capital Market Date, December 2013
				Yield
30-day Treasury Bill				0.1%
10-year Treasury Bill				2.8%
10-Year Corporate Bonds
of Industrial Companies
AAA				2.8%
AA				2.9%
A+				3.2%
A				3.3%
A-				3.5%
BBB+				3.8%
BBB				4.1%
BBB-				4.6%
BB+				5.8%
BB				6.5%
BB-				6.5%
B+				6.8%
B				8.4%
B-				9.0%
Historical Market Risk Premium
(Equity Market Index
Less Government Debt)				6.0%

Answer 1

The yield on chestnut food bond is 3.5 % given in the exibit 14.3

As tax rate is not mentioned in the question so Let us assume tax rate of 40%

then Cost of debt=yield (1-tax rate)

Cost of debt=3.5(1-.40)

Cost of debt =3.5(.60)

Cost of debt=2.1%

According to CAPM model cost of equity

Cost of equity =risk free rate+beta*(market risk premium)

risk free rate for 10 years treasury bill=2.8% given in th exibit 14.3

beta=.9 given in the exibit 14.4

market risk premium=6% given in the exibit 14.3

cost of equity=2.8+.9*6

cost of equity=2.8+5.4

cost of equity=8.2%

WACC=K_e*weight of equity+K_d*weight of debt

capital structure of company=Total debt+market value of equity

=461+1840

=2301

weight of equity=1840/2301*100=80% approx

weight of debt=461/2301*100=20% approx

WACC=8.8*80%+2.1*20%

WACC=0.0704+0.0042

WACC=7.46%