Kentucky Hardware Company (KHC) is considering an investment project that requires a new machine for $2,450,000. This
Question:
Kentucky Hardware Company (KHC) is considering an investment project that requires a new machine for $2,450,000. This new machine will be depreciated over 10 years on a straight-line basis toward a zero salvage value. KHC paid a consulting company $50,000 last year to help them decide whether there is sufficient demand for the machine’s products. In addition to the investment on the machine, KHC also invests $20,000 in net working capital but decides NOT to recoup the net working capital at the end of the investment project. KHC has estimated the performance of the new machine and believes that the new machine will produce $850,000 per year in sales, $300,000 per year in cost of goods sold, and $100,000 per year in administrative expenses. In order to get an estimate of cost of capital, KHC collects the following information. KHC expects to pay $2.1 of dividend next year. An estimated growth rate is 4%. The stock is currently selling for $35. The beta of KHC stock is 1.2. Debt similar to KHC’s is selling in the bond market at a price of $8,463. The bonds have 8% annual coupon rate, coupon paid semi-annually, 15 years to maturity and face value of $10,000. The risk free rate is 5% and the expected return on the market is 12.5%. KHC has a corporate tax rate of 30%. Currently KHC has the capital structure with 40% of debt and 60% of equity. Answer Questions 21 - 34 How much money does KHC need to spend to start the investment project (i.e., project cash flow at time 0)? a. $2,530,000 b. $2,500,000 c. $30,000 d. $2,470,000
2)
What is the annual project cash flow expected to be generated by the investment project?
| | a. | $140,000 |
| | b. | $850,000 |
| | c. | $600,000 |
| | d. | $390,000 |
What is the after-tax cost of debt for KHC?
| | a. | 7% |
| | b. | 9% |
| | c. | 10% |
| | d. | 8% |
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