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Compano Inc

Compano Inc., founded in 1986, provides oil-field services in Texas and reported a book value of assets at $830.5 million with a market value of $1.334 billion by year-end 2014. The firm's CFO initiated a cost of capital study to ensure new investments meet appropriate hurdles, leading to an analysis of current capital costs and the firm's capital structure. Key financial metrics include an 8.5% coupon rate on debt, a beta of 0.30 for corporate debt, and a corporate tax rate of 40%, which will inform the calculations for levered equity beta, cost of equity, and WACC.

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12 views1 page

Compano Inc

Compano Inc., founded in 1986, provides oil-field services in Texas and reported a book value of assets at $830.5 million with a market value of $1.334 billion by year-end 2014. The firm's CFO initiated a cost of capital study to ensure new investments meet appropriate hurdles, leading to an analysis of current capital costs and the firm's capital structure. Key financial metrics include an 8.5% coupon rate on debt, a beta of 0.30 for corporate debt, and a corporate tax rate of 40%, which will inform the calculations for levered equity beta, cost of equity, and WACC.

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f20221717
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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.

Liabilities and Owners’ Balance Sheet (Book values) Invested Capital (Market
Capital 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% $420,000,000 $434,091,171
interest paid semiannually,
due in 2015)
Total liabilities $435,516,000 $434,091,171
Owner’s Capital
Common stock ($1 par value $40,000,000
per share)
Paid-in-capital 100,025,000
Accumulated earnings 255,000,000
Total owner’s capital $395,025,000 $900,000,000
Total liabilities and owners’ $830,541,000 $1,334,091,171
capital

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?(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?

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