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Part II: During the last few years, Kelpie Industries has been too constrained by the high cost of capital to make many capital investments. Recently,
Part II: During the last few years, Kelpie Industries has been too constrained by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining, and the company has decided to look seriously at a major expansion program that had been proposed by the marketing department. Assume that you are an assistant to Larry Jones, the financial vice-president. Your first task is to estimate Kepie's cost of capital. Jones has provided you with the following data, which she believes may be relevant to your task: a) The firm's tax rate is 40 percent. b) The current price of S1000 par of Kepie's 12 percent coupon, semiannual payment, bonds with 15 years remaining to maturity is $1,153.72 c) The current price of the firm's preferred stock is $113.10, and it pays a $10 ammual dividend. d) Kelpie's common stock is currently selling at $50 per share. Its last dividend was $4.38, and dividends are expected to grow at a constant rate of 5 percent in the foreseeable future. Kelpie's beta is 12 the risk-free rate is 7 percent, and the market is expected to retum 13 percent. ) Kelpie's target (or optimal) capital structure of 10% preferred stock, 30% debt, and 40% common stock 1. What is Kopie's weighted average cost of capital (WACC)? (15) After tax cost of debt = 6% Cost of Common Equity = 7%+1.2* (13%-7) 14.2% Weight of equity 1 Part II Continues on the next page Kelpie Industries is considering the following mutually exclusive projects, which Leigh Jones has asked you to evaluate Year Project 1 Project 2 0 $(50,000,000) $(25,000,000) 1 $15,000,000 $5,000,000 2 $15,000,000 $10,000,000 3 $15,000,000 $5,000 000 4 $15,000,000 $11,000,000 5 $15,000,000 $10,000,000 Specifically, Jones has asked you to compute the following for each project: 2. Net Present Value (NPV) (5) Project 3 $(50,000,000) S22,000,000 $17,000,000 $13,500,000 $10,000,000 $8,000,000 3. Internal Rate of Return (IRR) (5) Part II continues on the next page 4. Payback Period (Kelpie requires all new projects have a payback period of 4 years or less) (5) 5. Which of these projects should be accepted? Justify your choice. (3)
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