Question
The firm's tax rate is 40%. The current price of TPIT 12% coupon, semiannual payment, non-callable bonds with 15 years remaining to maturity is $1,153.72.
The firm's tax rate is 40%.
The current price of TPIT 12% coupon, semiannual payment, non-callable bonds with 15 years remaining to maturity is $1,153.72. TPIT does not use short-term interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost.
The current price of the firms 10%, $100 par value, quarterly dividend, perpetual preferred stock is $116.95. TPIT would incur flotation costs equal to 5% of the proceeds on a new issue.
TPIT's common stock is currently selling at $50 per share. Its last dividend was $3.12, and dividends are expected to grow at a constant rate of 5.8% in the foreseeable future. TPIT's beta is 1.2, the yield on T-bonds is 5.6%, and the market risk premium is estimated to be 6%.
Suppose the firm has historically earned 15% on equity (ROE) and retained 35% of earnings, and investors expect this situation to continue in the future. How could you use this information to estimate the future dividend growth rate, and what growth rate would you get? Is this consistent with the 5.8% growth rate given earlier?
TPIT's target capital structure is 30% long-term debt, 10% preferred stock, and 60% common equity.
Suggested questions
What sources of capital should be included when you estimate TPIT's weighted average cost of capital (WACC)?
Should the component costs be figured on a before-tax or an after-tax basis?
Should the costs be historical (embedded) costs or new (marginal) costs? Explain?
TPIT' preferred stock is riskier to investors than its debt, yet the preferred yield to investors is lower than the yield to maturity on the debt. Does this suggest that you have made a mistake? (Hint: Think about taxes.)
What is the market interest rate on TPIT's debt and what is the component cost of this debt for WACC purposes?
What is the corporate cost of capital?
Part 2
Jim Jones was worried that whether the corporate cost of capital would be appropriate to evaluate the four segments project. His concern centered on whether the risk of the projects is reflected on the corporate cost of capital? What is the logical method of adjusting the cost of capital for risk? Is it wise to use the corporate cost of capital to evaluate the four segments projects?
Discuss the quantitative methods that are useful to evaluate the projects?
Discuss the strengths and weakness of each quantitative method you have selected to evaluate the projects?
Will all of the quantitative methods rank the projects identically? Why or why not?
Rank the projects on the basis of the measurements discussed above.
| Annual cash flows: | Annual cash flows: | Annual cash flows: | Annual cash flows: | ||||
| Energy | Transportation | Chemical | Construction | ||||
Year | EA | EB | TC | TD | CHE | CHF | ConG | ConF |
0 | ($1,500,000) | ($1,500,000) | $ (650,000) | ($200,000) | ($350,000) | ($300,000) | ($200,000) | ($200,000) |
1 | $450,000 | $440,000 | $ 210,000 | $97,000 | $144,000 | $43,000 | $88,500 | $101,000 |
2 | $650,000 | $440,000 | $ 210,000 | $97,000 | $144,000 | $98,000 | $91,000 | $78,000 |
3 | $650,000 | $440,000 | $ 210,000 | $97,000 | $144,000 | $152,000 | $88,000 | $87,000 |
4 | $440,000 | $540,000 | $ 210,000 | $97,000 | $144,000 | $168,000 | $88,000 | $87,000 |
5 | $330,000 | $540,000 | $ 210,000 | $97,000 | $144,000 | $184,000 | $88,000 | $87,000 |
6 | $250,000 | $540,000 | $ 210,000 | $97,000 | $144,000 | $200,000 | $88,000 | $87,000 |
Comparable Companies- Energy | Market Cap Mil | Net Income Mil | Interest Coverage | D/E | Equity Beta |
Unit Corp | 1,346 | 30 | 0.6 | 1.2 | |
Omv AG (USD,EUR) | 21,927 | -151 | -0.9 | 0.4 | 0.6 |
Omv AG (USD,EUR) | 21,927 | -151 | -0.9 | 0.4 | 0.6 |
Helmerich & Payne Inc (USD) | 7,725 | -128 | -8.3 | 0.1 | 0.4 |
RSP Permian Inc (USD) | 6,553 | 92 | 0.2 | 0.4 | 0.5 |
Patterson-UTI Energy Inc (USD) | 5,445 | -267 | -11.3 | 0.2 | 0.3 |
Transocean Ltd (USD) | 4,538 | -2,773 | 3.3 | 0.5 | 0.5 |
Ensco PLC (USD) | 2,998 | -57 | 5.4 | 0.6 | 0.8 |
Diamond Offshore Drilling Inc (USD) | 2,693 | 166 | -4.2 | 0.5 | 1 |
Ocean Rig UDW Inc (USD) | 2,614 | -3,809 | -14.2 | 0.2 | 0.75 |
Nabors Industries Ltd (USD) | 2,581 | -766 | -5.5 | 1.4 | 1.3 |
Rowan Companies PLC (USD) | 2,009 | -63 | 3.1 | 0.5 | 0.8 |
CES Energy Solutions Corp (USD,CAD) | 1,325 | 29 | -1.6 | 0.7 | 0.9 |
Noble Corp PLC (USD) | 1,249 | -1,794 | -3.3 | 0.7 | 0.85 |
SONGA OFFSHORE SE (USD) | 1,062 | -40 | 0.6 | 2.3 | 1.5 |
Ensign Energy Services Inc (USD,CAD) | 957 | -146 | -5.6 | 0.4 | 0.55 |
Sabine Royalty Trust (USD) | 708 | 33 | 0.3 | ||
Trinidad Drilling Ltd (USD,CAD) | 398 | -73 | -0.8 | 0.4 | 0.25 |
Seadrill Partners LLC (USD) | 346 | 216 | 4.5 | 2.5 | 1.8 |
Pioneer Energy Services Corp (USD) | 287 | -98 | -4.4 | 1.8 | 1.35 |
Archer Ltd (USD) | 219 | -2 | -1.6 | 2.9 | 1.8 |
Fred Olsen Energy ASA (USD) | 201 | -185 | -1.1 | 1 | 0.85 |
Fred Olsen Energy ASA (USD) | 201 | -185 | -1.1 | 1 | 0.75 |
Independence Contract Drilling Inc (USD) | 197 | -28 | -6.2 | 0.2 | 0.3 |
Pantheon Resources PLC (USD) | 171 | -1 | 0.5 | ||
Xtreme Drilling Corp (USD,CAD) | 138 | -82 | -18 | 0.5 | |
Industry Average | 1,779 | 1 | -522.2 | 0.6 |
Comparable Companies- Transportation
|
Market Cap Mil |
Net Income Mil |
Interest Coverage
|
D/E
| Equity Beta
|
Union Pacific Corp | 110,542 | 4,578 | 10.7 | 0.8 | 1.06 |
Canadian National Railway Co (USD,CAD) | 60,016 | 3,891 | 11.3 | 0.6 | 0.85 |
CSX Corp (USD) | 51,880 | 1,789 | 5.7 | 1.1 | 1.33 |
Norfolk Southern Corp (USD) | 43,898 | 1,852 | 5.6 | 0.7 | 1.54 |
East Japan Railway Co (USD,JPY) | 39,937 | 291,733 | 6.8 | 0.9 | 0.9 |
Central Japan Railway Co (USD,JPY) | 37,319 | 398,785 | 10.3 | 1.5 | 0.43 |
Canadian Pacific Railway Ltd (USD,CAD) | 26,283 | 1,805 | 5.6 | 1.3 | 1.14 |
Kansas City Southern (USD) | 11,545 | 539 | 7.8 | 0.5 | 0.73 |
Westinghouse Air Brake Technologies Corp (USD) | 7,856 | 251 | 0.7 | 0.92 | |
Guangshen Railway Co Ltd (USD,CNY) | 5,652 | 952 | 1.37 | ||
Industry Average | 13,429 | 29,956 | 15.9 | 0.8 |
|
Comparable Companies- Chemical
| Market Cap Mil | Net Income Mil | Interest Coverage | D/E
| Equity Beta
|
Eastman Chemical Co | 13,917 | 1,009 | 4.7 | 1.3 | 1.21 |
A. Schulman Inc (USD) | 1,128 | 44 | 1.6 | 4.2 | 1.84 |
Asahi Kasei Corp (USD,JPY) | 18,510 | 132,954 | 36.5 | 0.2 | 0.3 |
Ashland Global Holdings Inc (USD) | 4,540 | 1 | 0.6 | 0.8 | 1.31 |
Balchem Corp (USD) | 2,583 | 64 | 12.4 | 0.4 | 0.5 |
Basf SE (USD,EUR) | 108,362 | 5,230 | 9.2 | 0.4 | 1.03 |
Bio-En Holdings Corp (USD) | 129 | 0 | -27.9 | -0.63 | |
BioAmber Inc (USD) | 23 | -24 | -8.8 | 0.2 | 3.16 |
Industry Average | 11,925 | 29,851 | 125.4 | 0.5 | 1.09 |
| Market Cap Mil | Net Income Mil | Interest Coverage | D/E
| Equity Beta
|
| |||||
Vulcan Materials Co | 17,862 | 386 | 5.1 | 0.6 | 0.91 |
Daikin Industries Ltd (USD,JPY) | 36,579 | 159,019 | 24.3 | 0.3 | 0.83 |
Compagnie de Saint-Gobain SA (USD,EUR) | 32,398 | 1,311 | 5.7 | 0.4 | 0.39 |
CRH PLC (USD,EUR) | 30,435 | 1,327 | 6.2 | 0.6 | 0.96 |
Masco Corp (USD) | 14,438 | 544 | 4.6 | 1.45 | |
Martin Marietta Materials Inc (USD) | 14,267 | 435 | 8.4 | 0.4 | 1.32 |
Cemex SAB de CV (USD,MXN) | 11,943 | 21,512 | 1.8 | 1.1 | 1.35 |
Owens-Corning Inc (USD) | 10,682 | 379 | 0.6 | 0.73 | |
Asahi Glass Co Ltd (USD,JPY) | 10,275 | 75,138 | 10.1 | 0.3 | 0.5 |
James Hardie Industries PLC (USD) | 9,465 | 256 | 13.9 | 1.4 | |
Industry Average | 18834.4 | 26030.7 | 8.9 | 0.5375 |
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