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 producing special tools.  This new machine costs $1,000,000 and will be depreciated over 10 years on a straight-line basis toward zero salvage value.  KHC paid a consulting company $50,000 last year to help them decide whether there is sufficient demand for the special tools.  In addition to the investment on the machine, KHC also invests $30,000 in net working capital.  The company pays $45,000 in interest expenses annually.  KHC has estimated the performance of the new machine and believes that the new machine will produce $350,000 per year in sales, $130,000 per year in cost of goods sold, and $25,000 per year in administrative expenses.

In order to get an estimate of cost of capital, KHC collect the following information.  KHC has 310,000 shares of common stock outstanding, 15,000 shares of preferred stock outstanding, and 8,000 issues of corporate bond outstanding.  The bonds have face value $1,000 and coupon rate 6%.  The bonds make semiannual coupon payments, have 25 years to maturity, and sell for 131.423% of par.  The common stock sells for $56 per share and has a beta of 1.05.  KHC’s next common stock dividend is expected to be $2.80 per share, and the common stock dividend is expected to grow at 7.7% indefinitely.  The preferred stock sells for $72 per share and pays $4.5 annual dividend.  The market risk premium is 8%, T-bills are yielding 4.5%, and KHC’s tax rate is 25%.

QUESTION 9

What is KHC's market value capital structure?

$10,513,840

$28,953,840

$1,080,000

$17,360,000

QUESTION 10

What is the weighted average cost of capital for KHC?

9%

15%

6%

12%

QUESTION 11

What is the payback period for the investment project?

6.01 years

6.82 years

5.21 years

7.86 years

QUESTION 12

What is the net present value for the investment project?

$33,619.42

$69,023.88

-$25,278.31

$81,696.21

QUESTION 13

What is the internal rate of return for the investment project?

8.62%

10.75%

11.36%

9.43%

QUESTION 14

What is the profitability index for the project?

0.97

-1.08

-0.97

1.08

QUESTION 15

Should KHC accept the project?

Yes because the net present value is positive.

No because the profitability index is negative.

No because the internal rate of return is higher than the cost of capital.

Yes because the payback period is longer than the project life.

QUESTION 16

What is the maximum price that KHC has to pay if the target profitability index is 1.2?

$926,413.50

$1,735,777.27

$1,982,439.50

$999,112.62

QUESTION 17

What is the minimum annual cash flow that project has to generate in order to accept the project?

$160,494.69

$316,297.91

$145,396.85

$329,597.61

$10,513,840

$28,953,840

$1,080,000

$17,360,000

Explanation / Answer

Kentucky Market Value Weight Cost Debt 10,513,840 36.31% 4% Pref. Stock 1,080,000 3.73% 6% Equity 17,360,000 59.96% 12.7% Total 28,953,840 WACC 9% 0 1 Investment -1,000,000 NWC -30,000 Sales 350,000 COGS -130,000 Admin -25,000 Depreciation -100,000 EBT 95,000 Tax (25%) -23,750 Net Income 71,250 Cash Flows -1,030,000 171,250 PBP 6.01 NPV $66,976.10 PI $1.07 IRR 10.75%

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