Orion Corporation is discussing a new capital expenditure project that requires an investment of €100 million. In line with the target capital structure of Orion, the management of the company has prepared the following funding plan: - A 5-year zero-coupon bond with face value of €32 million, priced at 80% of its face value. - A 5-year coupon bond, with 4% annual coupons, face value of €26 million, priced at 95% of its face value.              -Preferred shares with a total €18 million face value. The issue price is at €40 with a preferred coupon of 12%. The flotation expenses are 2% on the issue price. -The remaining financing needs will be covered from retained earnings. Currently, the stock of the company trades at €50, the last dividend payment was €2.5 per share, and the expected growth rate for dividends is 8 percent. In addition, the beta of the stock is 1.4, the risk-free rate is 4 percent, and the expected market risk premium is 8 percent. Questions: 1. Estimate the WACC of Orion under the CAPM and DDM models, considering that the corporate tax rate is 35 percent. 2. Are the two estimates the same? In case that the two methodologies result to different estimates, how you would explain this? 3. Assuming that the management of Orion is conservative, which estimate you would propose to them to apply in this investment project?

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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Orion Corporation is discussing a new capital expenditure project that requires an investment of €100 million. In line with the target capital structure of Orion, the management of the company has prepared the following funding plan:
- A 5-year zero-coupon bond with face value of €32 million, priced at 80% of its face value.
- A 5-year coupon bond, with 4% annual coupons, face value of €26 million, priced at 95% of its face value.              -Preferred shares with a total €18 million face value. The issue price is at €40 with a preferred coupon of 12%. The flotation expenses are 2% on the issue price.
-The remaining financing needs will be covered from retained earnings. Currently, the stock of the company trades at €50, the last dividend payment was €2.5 per share, and the expected growth rate for dividends is 8 percent. In addition, the beta of the stock is 1.4, the risk-free rate is 4 percent, and the expected market risk premium is 8 percent.


Questions:
1. Estimate the WACC of Orion under the CAPM and DDM models, considering that the corporate tax rate is 35 percent.
2. Are the two estimates the same? In case that the two methodologies result to different estimates, how you would explain this?
3. Assuming that the management of Orion is conservative, which estimate you would propose to them to apply in this investment project? 

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