Compano Inc was founded in 1986 in Baytown Texas The
Compano Inc. was founded in 1986 in Baytown, Texas. The firm provides oil-field services to the Texas Gulf Coast ­region, including the leasing of drilling barges. Its balance sheet for year-end 2014 describes a firm with $ 830,541,000 in book value assets that has a market value of $ 1.334 billion.
Compano’s executive management team is concerned that its new investments be required to meet an appropriate cost of capital hurdle before capital is committed. Consequently, the firm’s CFO has initiated a cost of capital study by one of his senior financial analysts, Jim Tipolli. Jim’s first action was to contact the firm’s investment banker to get input on current capital costs. Jim learned that, although the firm’s current debt capital required an 8.5% coupon rate of interest (with annual interest payments and no principal repayments until 2025), the current yield on similar debt would decline to 8% if the firm were to raise debt funds today. When he asked about the beta for Compano’s debt, Jim was told that it was standard practice to assume a beta of .30 for the corporate debt of firms such as Compano.
a. What are Compano’s capital structure weights for debt and equity that should be used to compute its cost of capital?
b. Based on Compano’s corporate income tax rate of 40%, the firm’s mix of debt and equity financing, and an unlevered beta estimate of .90, what is Compano’s levered equity beta?
c. Assuming a long-term US Treasury bond yield of 5.42% and an estimated market risk premium of 5%, what should Jim’s estimate of Compano’s cost of equity be if he uses CAPM? d. What is your estimate of Compano’s WACC?
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