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FIN - Compano inc. (4-4 THREE-STEP PROCESS FOR ESTIMATING A FIRMS WACC)

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Question;4-4 THREE-STEP PROCESS FOR ESTIMATING A FIRMS WACC,Compano inc. was founded in 1986 in Baytown, Texas. The firm providesoil-field services to the Texas Gulf Coast region, including the leasing ofdrilling barges. Its balance sheet for year-end 2006 describes a firm with830,541,000 in assets (book values) and invested capital of more than 1.334billion (based on market values).December 31, 2006Liabilities and owners capitalBalance sheetInvested Capital(Book value)(Market values)Current LiabilitiesAccounts Payable8,250,000Notes payable0Other current liabilities7,266,000Total current liabilities015,516,000Long term debt (8.5% interest paidSemiannually, due in 2015)420,000,000 434,091,171Total liabilities435,516,000 434,091,171Owners capitalCommon stock ($1 par value per share) 40,000,000Paid in capital100,025,000Accumulated earnings255,000,000Total owners capital395,025,000Total liabilities and owners capital 830,541,000 1,334,091,171Companos executive management team is concerned that its newinvestments be required to meet an appropriate cost of capital hurdle beforecapital is committed. Consequently, the firms CFO has initiated a cost ofcapital study by one of his senior financial analysts, Jim Tipolli. Jims firstaction was to contact the firms investment banker to get input on currentcapital costs.Jim learned that although the firms current debt capital required an 8.5%coupon rate of interest (with annual interest payments and no principalrepayments until 2015), the current yield on similar debt had declined to 8%if the firm were to raise debt funds today. When he asked about the beta forcompanos debt, Jim was told that it was standard practice to assume a betaof.30 for the corporate debt of firms such as Compano.A. What are Companos total invested capital and capital structureweights for debt and equity?B. Based on Companos corporate income tax rate of 40%, the firmscurrent capital structure, and an unlevered beta estimate of.90. Whatis Companos levered equity beta?C. Assuming a long term U.S. Treasury bond yield of 5.42% and anestimated market risk premium of 5%, what should Jims estimate ofCompanos cost of equity be if he uses the CAPM?D. What is your estimate of Companys WACC?

 

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