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 SESO’s 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.

Required:
a. Calculate the cost of equity for SESO. What are some of the limitations of the method that you used?
b. Calculate the cost of debt. What assumption did you make in order to perform this calculation?
c. Assume that SESO has 5 million shares outstanding. What is the market capitalization of Serton? 4. What is the WACC of Serton?