15.9 The Gulf Power Company is an electric utility that is planning to build a new conventional power plant. The company has traditionally paid out all earnings to the stockholders as dividends, and has financed capital expenditures with new issues of common stock. There is no debt or preferred stock presently outstanding. Data on the company and the new power plant follow. Assume all earnings streams are perpetuities.

Company Data Current annual earnings: $27 million Number of outstanding shares: 10 million New Power Plant Initial outlay: $20 million Added annual earnings: $3 million Management considers the power plant to have the same risk as existing assets. The current required rate of return on equity is 10 percent. Assume there are no taxes and no costs of bankruptcy.

a. What will the total market value of Gulf Power be if common stock is issued to finance the plant?

b. What will the total market value of the firm be if $20 million in bonds with an interest rate of 8 percent are issued to finance the plant? Assume the bonds are perpetuities.

c. Suppose Gulf Power issues the bonds. Calculate the rate of return required by stockholders after the financing has occurred and the plant has been built.