Kirksville Inc. has 1,100 bonds outstanding that are selling for $992 each. The
ID: 2744812 • Letter: K
Question
Kirksville Inc. has 1,100 bonds outstanding that are selling for $992 each. The bonds carry a 6.0 percent coupon, pay interest semi-annually, and mature in 7.5 years. The company also has 9,500 shares of 5% preferred stock at a market price of $40 per share. This month, the company paid an annual dividend in the amount of $1.20 per share. The dividend growth rate is 5.0 percent. The common stock is priced at $30 a share and there are 34,500 shares outstanding. The company is considering a project that is equally as risky as the overall company. This project has initial costs of $630,000 and operating cash flows of $150,000 a year for the next 10 years and salvage value of $10,000 at the end of 10 years. The net working capital (NWC) is expected to increase by $10,000 a year until the end of the project life.. The project will be depreciated straight-line to zero over the project’s 10-year life. The tax rate is 34%.
a. What is Kirksville’s weighted average cost of capital?
b. What is the net present value (NPV) of this project? Should you accept the project? Explain why.
c. What is the internal rate of return (IRR) of this project? Should you accept the project if you apply the IRR decision rule?
Explanation / Answer
Answer a Kriks ville Inc. WACC Particulars Qty Current Mkt Rate Current Mkt Value Weight Cost Wt*Cost Bonds 1100 992 1091200 43.54% 3.96% 1.72% Preferred Stock 9500 40 380000 15.16% 5.00% 0.76% Common Stock 34500 30 1035000 41.30% 9.00% 3.72% Total Mkt value of stock & debt 2506200 100.00% 6.20% WACC = 6.20% Working Notes Calculation of cost Cost of Equity P = D/Ke-g 30 = 1.20/Ke-0.05 Cost of Equity = 9% Cost of Preferred Stock = 5% Cost of Debt = rd(1-tax rate) = 6.0(1-0.34) = 3.96% Answer b Net Present Value Operating Cash Flow 150000 PVIFA 6.20%, 10 Years 7.2908 P V of Cash Flow 1093620 add Salvage value 10000 PVIF 6.20%, 10 Years 0.548 5480 Total PV 1099100 Less Initial outlay 630000 NPV 469100 Projected should be accepted, Because its NPV is positive. Answer C IRR Year cash flow 0 (630,000) 1 150000 2 150000 3 150000 4 150000 5 150000 6 150000 7 150000 8 150000 9 150000 10 160000 IRR 20.0% Checking the IRR Net Present Value Operating Cash Flow 150000 PVIFA 20%, 10 Years 4.1925 P V of Cash Flow 628875 add Salvage value 10000 PVIF 20%, 10 Years 0.1615 1615 Total PV 630490 Less Initial outlay 630000 NPV 490 IRR of the project will be 20%. IRR is more than the required rate of return. Therefore, project should be accpeted.
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