Weighted average cost of capital

Assignment Help Operation Management

Reference no: EM131012677

Texas GenCo is an electric utility that operates coal-fired generating capacity. Like most electric utilities it maintains a moderately high debt/equity ratio of 2.2, a low equity beta coefficient of 0.72 and an even lower debt beta of just 0.18. Suppose the current riskless rate of interest is 3.25% and the expected return on the S&P 500 market index (taken as the diversified market portfolio) is 8.25%. 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. What is the current weighted average cost of capital for Texas GenCo? Texas GenCo is contemplating purchasing a coal mine to supply its power plants. Realizing that the risk in the coal mining business is different from electric utility risks, Texas GenCo wants to use the financial data from a comparable coal-mining firm to determine the appropriate discount rate for the vestment. The best available comparable firm, American Coal Corp, has a capital structure with 25% debt. The CAPM beta coefficient on American Coal's equity is 2.65, while the beta for its debt is 0.62. Texas GenCo believes that the fundamental risks inherent in the new venture are identical to the fundamental risks reflected in American Coal Corp's debt and equity returns. However, since the new venture will be a small part of Texas GenCo's overall assets, Texas GenCo intends to use its own leverage ratio to finance the new venture and will be able to borrow at an interest rate just 1.5 percentage points above its current bond yield.

What weighted average cost of capital should Texas GenCo use to evaluate the NPV of the cash flows associated with the coal mining investment?

Reference no: EM131012677

Questions Cloud

Initial margin requirements : Ted’s Corporation stock is selling for $50 per share. Ted pays no dividends. Initial margin requirements are 50%, and maintenance margin requirements are 30%. You can borrow from your broker at 7% per year on margin debt, but the broker pays nothing ..

National social marketing campaign : What challenges might you expect when adapting a national social marketing campaign in your local community

Derive the formula for w as a function of h : The laboratory apparatus we used to measure hydrostatic forces is shown below. Derive the formula for ''W'' as a function of ''h''. b) Plot h versus W. Use the actual values that we used during the lab session for L, Y and b.

Standard costs are difficult to use with a process costing : Standard costs require that significant unfavorable variances be investigated, but do not require that significant favorable variances be investigated.

Weighted average cost of capital : What weighted average cost of capital should Texas GenCo use to evaluate the NPV of the cash flows associated with the coal mining investment?

Explain famous experiments tells us about human nature : Explain what one of these famous experiments tells us about human nature. Why is the experiment relevant to an ethics course

Calculating average payable period : Calculating average payable period: Hare, Inc., had a cost of good sold of $57,382. at the end of the year,the accounts payable balance was $10432. how long on average did it take the company to pay off its suppliers during the year? what might a lar..

Total cash flows over the project life : Explain. Typically, a project will have a higher NPV if the firm uses accelerated rather than straight-line depreciation. This is because the total cash flows over the project's life will be higher if accelerated depreciation is used, other things..

How the current news story or event identified : Connect the dots in your post and show how the current news story or event relates to an ethical issue or theory identified in the text and/or discussion

User Account

All Pages