Three-Step Process for Estimating a Firm’s WACC 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. December 31, 2014 Liabilities and Owners’ Capital Balance Sheet (Book Values) Invested Capital (Market Values) Current liabilities Accounts payable $ 8,250,000 Notes payable — — Other current liabilities 7,266,000 Total current liabilities $ 15,516,000 $ — Long-term debt (8.5% interest paid semiannually, due in 2015) $420,000,000 $ 434,091,171 Total liabilities $435,516,000 $ 434,091,171 Owners’ capital Common stock ($1 par value per share) $ 40,000,000 Paid-in-capital 100,025,000 Accumulated earnings 255,000,000 Total owners’ capital $395,025,000 $ 900,000,000 Total liabilities and owners’ capital $830,541,000 $1,334,091,171 Company'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 Tripoli. 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 the similar debt would decline to 8% if the firm were to raise debt funds today. When he asked about the beta for Company'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? (Hint: Compano plans on maintaining the mix of financing over time

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?

a. Evaluate the capital structure weights
Enterprise Value = Market Capitalization + Debt
Debt / Enterprise Value
Equity / Enterprise Value
b. Estimate leveraged equity beta
Cost of Debt (after taxes)
Debt/Equity Ratio
Levered equity beta
c. Estimate cost of equity
Cost of equity
d. Estimate WACC (using worksheet below)
WACC
Worksheet:
Source of Capital	Capital Structure Weighting	After-Tax Cost	Weighted After-Tax Cost

Answer rating: 100% (QA)

1 Weight of debt debtTotal liabilities and owners capital 434091171... View the full answer