Subsidies-Subsidies-More-Subsidies (SSM), a wind energy producer, is considering building a new power plant. The project involves the same level of risk as SSM's current operations.
The project requires an initial cash investment of $1, 500,000, and has projected cash inflows of $500,000 in year one, $700,000 in year two, and $800,000 in year three (and no flows afterwards). SSM has 5,000,000 shares outstanding, and its share price is $15.
Market beta of SSM's shares is 1.5. The risk-free rate is 2%, and the market risk premium is 5%. SSM also has $25,000,000 of debt (both in terms of market and book values), with a yield-to-maturity of 5%. SSM's tax rate is 35%
a. What is SSM's cost of equity?
b. What is SSM's (pre-tax) cost of debt?
c. What is the weighted average cost of capital for SSM?
d. What is the discount rate SSM should use to evaluate the power plant project?
e. Compute the NPV for the power plant project.