Kentucky Hardware Company (KHC) is considering an investment project that requires a new machine for producing special tools. This new machine costs $1,000,000 and will be depreciated over 10 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 $30,000 in net working capital. The company pays $45,000 in interest expenses annually. KHC has estimated the performance of the new machine and believes that the new machine will produce $350,000 per year in sales, $130,000 per year in cost of goods sold, and $25,000 per year in administrative expenses.

In order to get an estimate of cost of capital, KHC collect the following information. KHC has 310,000 shares of common stock outstanding, 15,000 shares of preferred stock outstanding, and 8,000 issues of corporate bond outstanding. The bonds have face value $1,000 and coupon rate 6%.

The bonds make semiannual coupon payments, have 25 years to maturity, and sell for 131.42% of par. The common stock sells for $56 per share and has a beta of 1.05. KHC's next common stock dividend is expected to be $2.80 per share, and the common stock dividend is expected to grow at 7.7% indefinitely. The preferred stock sells for $72 per share and pays $4.5 annual dividend. The market risk premium is 8%, T-bills are yielding 4.5%, and KHC's tax rate is 25%.

Sales

COGS

Gross margin

Administrative expenses

Depreciation

EBIT

Taxes (25%)

Net income

OCF

0 1 2 3 4 5 6 7 8 9 10

OCF

Capital spending

Change in NWC

Total cash flow

Cumulative cash flow

Using the Dividend Growth Model, what is the cost of equity?

Using the Capital Asset Pricing Model, what is the cost of equity?

What is the average cost of equity

What is the after-tax cost of debt?

What is the cost of preferred stock?

What is the market value of common stocks?

What is the market value of corporate bonds?

What is the market value of preferred stocks?

What is the percentage of common stock financing?

What is the percentage of corporate bond financing?

What is the percentage of preferred stock financing?

What is the weighted average cost of capital?

What is the payback period?

What is the net present value?

What is the internal rate of return?

What is the profitability index?

Should KHC accept the investment project?