Question 5. Texas Gen Co operates natural gas generating plants. It maintains a capital structure with 45% debt, has an equity beta coefficient of 1.1 and a debt beta of 0.22. It currently has $4.032 billion of debt, no retained earnings and an overall market value of $8.96 billion. Suppose the current riskless rate of interest is 2.25% and the expected return on the S&P 500 market index (taken as the diversified market portfolio) is 8.41%. Assume that the corporate tax rate is 34% and that the corporate tax effect of debt approximates the overall effect of debt on firm market value. (a) (4 points) What is the current weighted average cost of capital for Texas GenCo? (b) (1 point) Write down the market value balance sheet for Texas Gen Co giving financial amounts in $million. Texas Gen Co now announces that it intends to invest in a new 620MW combined cycle gas plant. The capital cost is expected to be $568.54 million, depreciable on a straight-line basis over 25 years. Texas Gen uses the risk-free rate to discount the depreciation tax benefits. (c) (2 points) Recalling that the corporate tax rate is 34%, calculate the present value of the anticipated depreciation tax benefits. The new plant is expected to have tax-deductible fixed O&M costs of $8.1654 million per year. Given the heat rate for the plant, prevailing natural gas prices, and an anticipated usage factor of 60% for the plant, Tex Gen anticipates incurring tax-deductible annual variable costs of $11.7314 million. Given an expected average wholesale electricity price of 3.5/kWh over the 25-year life of the plant, it anticipates earning $114.0552 million per year in revenue. (d) (2 points) Calculate the present value of the after-tax risky cash flow discounting at the weighted average cost of capital, rw. (e) (2 points) Hence obtain the overall NPV of the proposed investment project. If capital markets are informationally efficient, what should happen to the market value of the firm's equity the day of the announcement? Write down the market value balance sheet of Texas Gen (in $million) immediately following the announcement of the project and before any debt or equity has been floated to fund the investment. (f) (4 points) Noting that Texas Gen needs to raise $568.54 million, how should this be split between new equity and debt given that Texas Gen wants to maintain its current capital structure? Write down the market value balance sheet of Texas Gen (in $million) immediately following the equity and debt float but before construction of the new plant (g) (1 point) Finally, write down the market value balance sheet immediately after the plant has been built
