Leland Industries is a producer of bakery and snack goods in Western Canada and are considering expending into Eastern Canada. The expansion is estimated to cost $10,000,000 for a new production facility. This project is in the same line of business as the firms current operations and is therefore not expected to alter the risk of the firm.

The most recent balance sheet is provided below.

	Leland Industries
	Balance Sheet
	As at Dec 31, 2021
Assets			Liabilities
Cash & Marketable Securities	$ 425,000		Accounts Payable	$ 300,000
Accounts Receivable	$ 400,000		Other Current Liabilities	$ 425,000
Inventories	$ 500,000		Total Current Liabilities	$ 725,000
Total Current Assets	$ 1,325,000
Net Fixed Assets	$ 18,000,000		LT Debt *	$ 6,500,000
			Preferred Stock **	$ 2,500,000
			Common Stock***	$ 3,000,000
			Retained Earnings	$ 6,600,000
			Total Liabilities &
Total Assets	$ 19,325,000		Owners Equity	$ 19,325,000

Notes to financial statements: * The 5% semi-annual coupon bonds have a face value of $1,000, were issued 5 years ago and have 10 years to maturity. The bonds are currently selling for a quoted price of 92.56. **The preferred shares have a $100 par value and 3.5% dividend and are currently selling for $43.75 per share. ***There are 500,000 common shares outstanding that are currently selling for $24.06 per share.

The CFO has gathered the information below to determine whether the project should be accepted.

a) b) c) d) e) f)

g) h)

i)

j)

Government of Canada 91-day Treasury bills are currently yielding 3%, the S&P/TSX Composite Index has a standard deviation = 15% and a return = 10%.

The marginal tax rate = 35% The firm has enough internally funds to finance the equity portion of this project. Flotation costs are expected to be as follows: new debt=5%, new preferred shares = 6% and new common shares = 7%. The most recent dividend paid was $1.75. Dividends are expected to grow at a constant rate =8%, forever. Assume flotation costs are expensed at time = 0. The expansion project is expected to produce annual cash flows before tax of $2,100,000 per year for the next fifteen years. The assets associated with the expansion will have no value in 15 years time. The Present Value of the CCA tax shield associated with the new project = $575,000

Calculate Lelands before- tax cost of debt. Calculate Lelands cost of preferred shares. Calculate Lelands cost of common equity using the Dividend Discount Model. Calculate Lelands cost of common equity using the Security Market Line. Calculate the capital structure weights. (5 marks) Calculate the discount rate that should be used to evaluate the expansion into Eastern Canada. Use your answer from (d) above in your calculation for the cost of equity.

(2 marks) Calculate the total initial investment for the expansion. (6 marks) Based on a NPV analysis, should Leland expand into Eastern Canada? Show your work. (6 marks) The firm is also considering another project (Project YUM) that has less risk than the firm. This new project will be financed using a D/E ratio = 0.65. A pure-play firm has been identified that has a beta = 0.75; D/E ratio = 1.5 and a tax rate = 40%. The cost of debt and tax rate for the new project will be the same as Lelands. Calculate the discount rate that should be used to evaluate this new project (Project YUM). (10 marks) Suppose the IRR of Project YUM = 7%. Should the firm accept or reject the project? Explain. (2 marks)