Kentucky Hardware Company (KHC) is considering an investment project that requir

Question

Kentucky Hardware Company (KHC) is considering an investment project that requires a new machine for $2,450,000. This new machine will be depreciated over 10 years on a straight-line basis toward a zero salvage value. KHC paid a consulting company $50,000 last year to help them decide whether there is sufficient demand for the machine’s products. In addition to the investment on the machine, KHC also invests $20,000 in net working capital but decides NOT to recoup the net working capital at the end of the investment project. KHC has estimated the performance of the new machine and believes that the new machine will produce $850,000 per year in sales, $300,000 per year in cost of goods sold, and $100,000 per year in administrative expenses. In order to get an estimate of cost of capital, KHC collects the following information. KHC expects to pay $2.1 of dividend next year. An estimated growth rate is 4%. The stock is currently selling for $35. The beta of KHC stock is 1.2. Debt similar to KHC’s is selling in the bond market at a price of $8,463. The bonds have 8% annual coupon rate, coupon paid semi-annually, 15 years to maturity and face value of $10,000. The risk free rate is 5% and the expected return on the market is 12.5%. KHC has a corporate tax rate of 30%. Currently KHC has the capital structure with 40% of debt and 60% of equity.

How much money does KHC need to spend to start the investment project (i.e., project cash flow at time 0)? a. $2,500,000 b. $30,000 c. $2,530,000 d. $2,470,000 2 points Saved QUESTION 22 What is the annual project cash flow expected to be generated by the investment project? a. $600,000 b. $140,000 c. $390,000 d. $850,000

What is the after-tax cost of debt for KHC? a. 7% b. 9% c. 8% d. 10%

What is the cost of equity for KHC by using the dividend growth model? a. 14% b. 10% c. 12% d. 11% 2 points

What is the cost of equity for KHC by using the capital asset pricing model? a. 14% b. 10% c. 12% d. 20% 2 points

What is the weighted average cost of capital for KHC? a. 11% b. 12% c. 10% d. 14%

What is the payback period for the investment project? a. 6.49 years b. 17.26 years c. 18.57 years d. 6.33 years 2 points Save

What is the net present value for the investment project? a. $133,618.83 b. -$133,618.83 c. -$73,618.83 d. $73,618.83 2 points

What is the internal rate of return for the investment project? a. 9.30% b. 11.29% c. 8.76% d. 10.68%

What is the profitability index for the project? a. 1.95 b. -0.97 c. 0.97 d. 0.95 2 points

1 Should KHC accept the project? a. Yes because the payback period is longer than the project life. b. No because the net present value is negative. c. Yes because the internal rate of return is lower than the cost of capital. d. No because the profitability index is negative.

What is the maximum price that KHC has to pay if the target profitability index is 1.1? a. $2,500,000.00 b. $2,178,528.34 c. $2,088,000.44 d. $2,282,267.78 2 points

What is the minimum annual cash flow that project has to generate in order to accept the project? a. $402,514.67 b. $411,745.85 c. $409,418.72 d. $401,981.13 2 points

If KHC's target weighted average cost of capital is 9%, what is the firm's target debt-equity ratio? a. 0.67 b. 1.5 c. 1.25 d. 0.5

Explanation / Answer

Question 1

The intial investment is 2,450,000 + 20,000 = 2,470,000. (Option d)

The $50,000 spent on forecasting the demand is a sunk cost and is not considered as apart of the inital investment

Question 2:

The annual cash flows are as follows:

Hence nearest Option is (c) $ 390,000

Question 3: The pretax cost of debt is the YTM calcualued as =rate(nper,pmt,pv,fv) in excel as in =rate(15 * 2,800/1,-8463,10000) = 5% (semi annual YTM)

Hence annual pretax cost of debt = 5 *2 = 10%

After tax cost of debt = 10*(1-0.3) = 7% (Option a)

Question 4: The Cost of equity as per dividend growth model = D1/ P0 + g = 2.1/35 + 0.04 =0.1 =10% (Option b)

Question 5 : The cost of equtiy a per CAPM = Rf + beta*(Rm - Rf) = 5 + 1.2*(12.5-5) = 14% (Option a)

Note: We have answered 5 sub-parts. Only 5 sub-parts will be answered at a time. Kindly repost remaining for experts to answer seperately.

Revenue 850000 Cost of Goods Sold 300000 Admin expense 100000 Depreciation 245000 Profit before tax 205000 Taxes 61500 PAT 143500 Add back :depreciation 245000 Net Cash flow 388500

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