Three-Step Process for Estimating a Firms 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

Companos 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 firms CFO has initiated a cost of capital study by one of his senior financial analysts, Jim Tipolli. Jims first action was to contact the firms investment banker to get input on current capital costs.

Jim learned that, although the firms 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 Companos debt, Jim was told that it was standard practice to assume a beta of .30 for the corporate debt of firms such as Compano.

What are Companos capital structure weights for debt and equity that should be used to compute its cost of capital?

Based on Companos corporate income tax rate of 40%, the firms mix of debt and equity financing, and an unlevered beta estimate of .90, what is Companos levered equity beta? (Hint: Compano plans on maintaining the mix of financing over time).

Assuming a long-term US Treasury bond yield of 5.42% and an estimated market risk premium of 5%, what should Jims estimate of Companos cost of equity be if he uses CAPM?

What is your estimate of Companos WACC?

Solution
Step 1: Evaluate the capital structure weights
Enterprise Value = Market Capitalization + Debt
Debt / Enterprise Value
Equity / Enterprise Value
Step 2: Estimate the costs of Financing
Debt (after taxes)
Debt/Equity Ratio
Equity
Levered equity beta
Step 3: Calculate the WACC
WACC	913.06%	9.13%
Capital Structure Weight
Source of Capital	(Proportion)	After-Tax Cost	Weighted After-Tax Cost
Debt
Equity
		WACC