Lisa Carter, CFO at Serton Software, reflected on her recent conversation with Michael Raston,

the CEO. Michael was concerned that because of changes in the market condition as well as

changes in the debt structure at Serton, the old yardstick for capital projects was no longer

reliable. With the market being somewhat stable after the financial crisis of 2008, Fed has been

planning to increase the rate slowly. Michael expects the long term rates to be higher than short

term rate. Lisa and Michael are debating which rate they should use as risk free rate (3-month T-

Bill, 5-year, or 10-year Treasury notes/bonds rates). Furthermore, 1 year ago, Serton had raised

$200 million by issuing 6% coupon (payable semi-annually) 14-year bonds at a price of 971.53.

These bonds are currently trading at $1063.13. This was in addition to the $300 million raised by

issuing 15-year 4.5% semiannual bonds at par two years ago.

Lisa recalled discussions with the board concerning the new bond issue. A particular board

member, Kathy Majewski, was citing financial research she encountered while doing her MBA at

the Wharton School. According to this research, bonds made sense mostly for firms paying a lot

of taxes. For these firms, the interest deduction is most valuable, compelling them to use debt at

the margin instead of internal or external debt. Kathy cited the fact that Serton passed much of its

global revenues through its subsidiaries in Ireland and the Netherlands and therefore only pays

about 10% of its profits as taxes. This rate was significantly below the corporate tax rate of 34%.

Although this discussion pertained to the corporate debt policy, Lisa wondered whether this tax

reality had anything to do with producing estimates of the corporate hurdle rate. Overall,

however, there were uncertainties about whether this situation (that is, low taxes) was tenable in

the long-term and whether Serton could continue to defer bringing back its cash from foreign

accounts (Note: the tax scheme of passing income through tax havens like Ireland also depended

on not needing the cash in the U.S. for the foreseeable future).

Linda tasked her assistant Jane Arches with crafting an appropriate response to her CEO. As a

first step, Jane downloaded SESOs stock price information along with data on the market index

for the previous 36 months (see the appendix following the case).

Assume that you are working with Jane to perform this analysis. Making appropriate

assumptions, informed by class discussions and by information in the finance text-book:

1.

Calculate the cost of equity for SESO. What are some of the limitations of the method

that you used?

2.

Calculate the cost of debt. What assumption did you make in order to perform this

calculation?

3.

Assume that SESO has 5 million shares outstanding. What is the market capitalization of

Serton?

4.

What is the WACC of Serton?

Appendix:

Monthly historical prices

Annualized treasury rates

Date

SESO

S&P

3 Mo

5 Yr

10 Yr

6/1/2015

119.22

2063.11

0.02

1.55

2.19

7/1/2015

115.29

2103.84

0.01

1.7

2.43

8/1/2015

107.33

1972.18

0.08

1.52

2.16

9/1/2015

105.31

1920.03

0.03

1.49

2.17

10/1/201

5

114.09

2079.36

0

1.37

2.05

11/1/201

5

112.95

2080.41

0.08

1.57

2.2

12/1/201

5

100.93

2043.94

0.21

1.59

2.15

1/1/2016

93.33

1940.24

0.22

1.73

2.24

2/1/2016

92.71

1932.23

0.35

1.38

1.97

3/1/2016

105.07

2059.74

0.33

1.31

1.83

4/1/2016

90.37

2065.30

0.23

1.24

1.79

5/1/2016

96.27

2096.95

0.22

1.32

1.88

6/1/2016

92.72

2098.86

0.3

1.39

1.85

7/1/2016

101.07

2173.60

0.28

1

1.46

8/1/2016

102.91

2170.95

0.29

1.06

1.51

9/1/2016

110.24

2168.27

0.33

1.18

1.57

10/1/201

6

110.72

2126.15

0.32

1.18

1.63

11/1/201

6

107.78

2198.81

0.35

1.3

1.83

12/1/201

6

113.52

2238.83

0.48

1.9

2.45

1/1/2017

118.94

2278.87

0.53

1.94

2.45

2/1/2017

134.27

2363.64

0.51

1.93

2.48

3/1/2017

141.42

2362.72

0.63

1.99

2.46

4/1/2017

141.41

2384.20

0.79

1.88

2.35

5/1/2017

150.38

2411.80

0.83

1.84

2.33

6/1/2017

142.36

2423.41

0.98

1.76

2.21

7/1/2017

147.02

2470.30

1.06

1.93

2.35

8/1/2017

162.11

2471.65

1.08

1.8

2.26

9/1/2017

152.94

2519.36

1.02

1.73

2.16

10/1/201

7

167.75

2575.26

1.01

1.94

2.34

11/1/201

7

170.54

2584.84

1.18

2.01

2.37

12/1/201

7

168.54

2673.61

1.27

2.13

2.37

1/1/2018

166.75

2823.81

1.44

2.25

2.46

2/1/2018

177.40

2713.83

1.48

2.56

2.78

3/1/2018

167.78

2640.87

1.63

2.58

2.81

4/1/2018

175.82

2677.84

1.77

2.55

2.73

4/16/201

8

175.82

2677.84

1.77

2.55

2.73

To start:

?

S&P index is used as market index

?

Beta Calculate monthly returns of market and stock. Then, regress risk premium of

stock on market risk premium to find beta

You can also refer this link:

Beta

?

For the CAPM model, find the most recent market risk premium used in the industry (cite

the source of your information).

?

Use bond-pricing theorem from chapter 8 to work on the bond part.