Problem: KHC is considering an investment project which needs a new machine for producing special tools. This new machine costs $1,000,000 and will be depreciated over 10 years on straight-line basis toward zero salvage value. KHC paid consulting company $50,000 last year to assist them decide whether there is sufficient demand for special tools. In addition to investment on machine, KHC as well invests $30,000 in net working capital however decides NOT to recoup the net working capital at the end of investment project. The company pays $45,000 in interest expenditures annually. KHC has estimated the performance of 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 acquire an estimate of cost of capital, KHC gather 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 a face value $1,000 and coupon rate 6%. The bonds make semi-annual coupon payments, have 25 years to maturity, and sell for 131.472% of par. The common stock sells for $56 per share and has beta of 1.05. KHC’s subsequently common stock dividend is expected to be $2.80 per share, and the common stock dividend is anticipated 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%.
Use the above detailed information to answer the problems.
problem1. How much money does KHC require to spend to start the investment project (that is, project cash flow at time 0)?
a. $30,000
b. $2,530,000
c. $1,030,000
d. $2,030,000
problem2. What is the annual project cash flow anticipated to be generated from investment project?
a. $137,500
b. $297,500
c. $100,000
d. $171,250
problem3. What is the after-tax cost of debt for the KHC?
a. 5%
b. 3%
c. 4%
d. 2%
problem4. What is cost of preferred stock for KHC?
a. 16
b. 6.25
c. 6.25%
d. 16%
problem5. What is the cost of equity for KHC by using dividend growth model?
a. 9.5%
b. 12.7%
c. 10.2%
d. 13.1%