Ithica Manufacturing Ltd. shares are publicly traded on the Toronto Stock Exchange. The shares currently trade at a price of $11.00 per share. Security analysts that follow the stock have estimated it's beta coefficient to be 1.5. Ithica paid a dividend on its common stock last year that totaled $0.08 per share. Dividends have been growing at a 2.25% compound rate for the past three years and the expectation is that this growth can continue into the foreseeable future.

Ithica Manufacturing Ltd. has a number of important capital projects to consider. The cogeneration project (CGP) is expected to produce annual cash flows before tax of $290,000 for each of the next twelve years. It is considered to be of similar risk to the risk of the firm itself. It will cost Ithica $750,000 this year to get this project up and running.

The U.S. expansion project (USEP) is expected to produce annual cash flows before tax of $1.2 million for each of the next five years. The project has operating risks in line with the overall risks undertaken by the firm. This project has an initial cost of $2.4 million.

There is also a product line extension (PLX) project that will require an initial investment of $1.2 million and is expected to produce annual after-tax cash flow benefits of $290,000 for each of the next six years.

Ithica has it's long-term bonds trading on public markets. The bonds are currently trading at a premium from their par value of 101.34%. These 6.35% bonds have eleven years left until they mature.

Sarah Painlyn, Ithica's Manager of Finance has collected current data from the firm's underwriters. Government of Canada 91-day Treasury bills are currently yielding 1.01%. The expected return on the S&P/TSX Capped Total Return Composite index is forecast to be 7.5% in 2017. New equity capital could be raised by the firm at the current market price, but floatation costs would amount of 5% of the value of the issue. New bonds could be sold into the market, but the floatation cost percentage would be 4%. The firm faces a corporate tax rate of 35%. If the firm goes ahead with the capital project, it will have to seek external financing.

a)Find the cost of retained earnings for Ithica. Are you confident in your estimates for the cost of retained earnings? Discuss.

b)Find the Ithicas WACC using market value weights. (Use an embedded Excel spreadsheet.)

c)Determine the IRR of each of the proposed CAPEX projects.

d)Prepare an properly-labeled Investment Opportunity Schedule.

e)If the firm doesnt practice capital rationing, which of the projects, if any, should be undertaken?

The firm's most recent financial statements are found below: Ithica Manufacturing Ltd. Balance Sheet As at December 31, 2016 In 000s Liabilities Assets 100 Cash Accruals Accounts Receivable Accounts Payable 1,220 2,450 Inventories Total Current Liabilities Total Current Assets 3,770 5,000 6.35% bonds Gross Fixed Assets Accumulated Depreciation 1,500 Common stock (2 million outstanding) Net Fixed Assets 3.500 Retained earnings 7.270 TOTAL ASSETS TOTAL CLAIMS 30 312 342 4,000 1,000 1.928 7.270