Please show detailed steps! Given the following information for Huntington Power

Question

Please show detailed steps!

Given the following information for Huntington Power Co. Assume the company’s tax rate is 35%.

Debt:               4,000 bonds outstanding, 7% coupon, $1000 par value, 20 years to    maturity, selling for 103% of par; the bonds make semiannual payments

            

              Common stock:         90,000 shares outstanding, selling for $57 per share; the beta is 1.10.

   Preferred stock:         13,000 shares of preferred stock outstanding, selling for $104 per share,        $6 annual dividend.

   Market:                     8% market risk premium and 6% risk-free rate

15. What is Huntington Power’s cost of debt (before tax)?

      

       a.     3.36 percent

       b.     6.00 percent

       c.     6.72 percent

       d.     7.00 percent

e.     8.00 percent

16. What is Huntington Power’s cost of common stock?

      

       a.     6.00 percent

       b.     8.20 percent

       c.     8.80 percent

       d.     14.00 percent

e.     14.80 percent

17. What is Huntington Power’s WACC?

      

       a.     9.60 percent

       b.     10.51 percent

       c.     11.81 percent

       d.     12.20 percent

e.     14.80 percent

18. Huntington Power is considering a project that will result in initial after-tax cash savings of $3.5 million at the end of the first year for 7 years. The cost-saving proposal is somewhat riskier then the usual project the firm undertakes; management uses the subjective approach and applied an adjustment factor of +2% to the cost of capital for such risky project. What is the NPV of the cost-saving project?

      

       a.     3,000,000.00

       b.     3,500,000.00

       c.     3,136,200.72

       d.     16,177,807.25

e.     17,266,214.14

Explanation / Answer

15) Cost of debt can be calculated using I/Y function on a calculator or RATE function in excel

Cost of debt = RATE(nper = 20*2, pmt = 7%*1000/2, pv = -103%*1000, fv = 1000, 0) x 2 = 6.72%

16) Cost of equity = Rf + beta x MRP = 6% + 1.1 x 8% = 14.80%

17) WACC = wd x kd x (1 - tax) + wps x kps + we x ke

= 39% x 6.72% x (1 - 35%) + 13% x 5.77% + 48% x 14.80% = 9.60%

18) NPV can be calculated using PV function

NPV = PV(rate = 9.6% + 2% = 11.2%, nper = 7, pmt = 3,500,000, fv = 0, 0)

= $16,77,807.25

Value Weight Cost Debt 4120000 39% 6.72% Pref. Stock 1352000 13% 5.77% Equity 5130000 48% 14.80% Total 10602000 WACC 9.60%

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