A firm is evaluating the possible purchase of a new machine that costs $ 400,000

Question

A firm is evaluating the possible purchase of a new machine that costs $ 400,000. An additional $20,000 will be incurred for shipping and installation. The machine will required an initial increase in net working capital of $75,000. The machine will be fully depreciated on a straight-line basis over the 5 years that the firm expects to keep the machine. At the end of the 5 years, it is expected that the machine will have a market value of $45,000. If the machine is purchased, the firm expects that its annual revenue will be $ 178,000 higher than without the machine. However annual operating expenses (exclusive of depreciation) will be higher as well to the extent o $24,000. The firm's marginal tax rate is estimated to be 40% The firm has 125,000 bonds outstanding, each with face value of $1000. These bonds have a coupon of 7.5%, pay interest semiannually, have 12 years remaining unit they mature, and are currently trading at $1176.12. Preferred shares for this firm are currently trading at $86.75. These have a face or par value of $100, and pay a fixed dividend of $6 per share in perpetuity. The firm has 325,000 of these shares outstanding. The firm has 4 million shares of common stock outstanding. These have just paid a divided of $3.15 (this is D_0). Analysis expect that the firm's earnings and dividends will grow at a constant rate 4.25% for the foreseeable future. Shares are currently trading at $41.24 (NOTE: Use just one model/method to figure the cost of equity). a) What is the firm's estimated after - tax cost of debt? b) What is the firm's estimated cost of preferred equity? c. What is the firm's estimated cost of common equity? d. What is the firm's estimated weighted average cost of capital (WACC)? e) What is the proposed project's IRR? Based solely on the IRR., should the project be taken? Why/Why not? f) What is the proposed project's NPV? Based solely on the NPV, should the project to taken? Why/why not?

Explanation / Answer

cost of debt = 7.50 * (1 - 0.40) = 4.50%

cost of preferred = 6 /100 = 6%

Cost of equity = dividend / stockrice + growth rate

                       = 3.15 / 41.24 + 4.25 = 11.89%

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