Murray Manufacturing currently has $15,000,000 in bonds outstanding with a coupon rate of 5.5% (semi-annual payments) and 10 years to maturity. The bonds are currently selling at a quoted price of 92. The company also has 12,000 shares of 5% preferred stock outstanding ($100 par), currently selling for $93 per share. In addition, the company has 350,000 common shares outstanding, selling for $55 per share. The firm has a tax rate of 35% and a beta of 1.25. You have observed the following from the market: an 8% market risk premium and 4.5% risk-free rate. Flotation cost to issue new preferred share is 5%, new debt is 3%, and new common share is 7%.

a) Calculate the discount rate the firm should use to evaluate projects with the same level of risk as the firm. (12 marks)

b) Murray Manufacturing is considering purchasing a new machine that will cost $550,000 plus an additional $125,000 in installation costs. Management estimates that the firm will obtain annual operating revenues before taxes of $400,000 and incur annual operating expenses before taxes of $245,000 over the economic life of the project. The specifications of this machine indicate an economic life of ten years and management estimates that at the end of the economic life, the machine will have a salvage value of $100,000. This machine is in asset class 9 which has a CCA rate of 15%. If the asset class is expected to remain open at the end of the project, based on NPV analysis, should the project be undertaken? Assume this project will not alter the risk of the firm. (10 marks)