Question
Kentucky Hardware Company (KHC) is considering an investment project that requires a new machine for producing special tools. This new machine costs $900,000 and will
Kentucky Hardware Company (KHC) is considering an investment project that requires a new machine for producing special tools. This new machine costs $900,000 and will be depreciated over 5 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 $40,000 in net working capital. The company pays $58,800 in interest expenses annually. KHC has estimated the performance of the new machine and believes that the new machine will produce $460,000 per year in sales. The cost of goods sold is 35% of sales and the administrative expenses is $35,000 per year.
In order to get an estimate of cost of capital, KHC collect the following information. KHC has 31,375 shares of common stock outstanding, 1,700 shares of preferred stock outstanding, and 980 issues of corporate bond outstanding. The bonds have face value $1,000 and coupon rate 6%. The bonds make semiannual coupon payments, have 15 years to maturity, and sell for 90.80398% of par. The common stock sells for $65 per share and has a beta of 1.1. KHCs next common stock dividend is expected to be $2.60 per share, and the common stock dividend is expected to grow at 7.6% indefinitely. The preferred stock sells for $80 per share and pays $7.04 annual dividend. The expected return of market portfolio is 11.5%, T-bills are yielding 2.5%, and KHCs tax rate is 20%.
What is KHC's project cash flow expected to be generated by the investment project at Year 5?
a. | $171,250 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
b. | $247,550 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
c. | $297,500 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
d. | $287,200 What is KHC's after-tax cost of debt?
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