Using the following information, The management of Blue Thumb Tools believes the firm’s current capital structure is optimal and intends to maintain it in the future. Blue Thumb’s bonds are selling for $950 each. Its common stock is selling for $37 a share and its preferred stock is selling for $88 per share. There are 50,000 bonds outstanding, 10,000,000 shares of stock and 3,000,000 shares of preferred stock outstanding, respectively.
Blue Thumb’s stock has a beta of 1.2. The current t-bill yield (risk-free rate,Rf) is 5.5% and the expected return on the market portfolio (Rm) is 11.5%. The company’s preferred stock pays an $8.50 per share dividend each year and the price of it is $88 per share. The yield to maturity of Blue Thumb’s bonds is currently 9.7%. Blue Thumb is in the 30% tax bracket.
Suppose Blue Thumb Tools is considering the introduction of a new, heavier hammer to be used for driving spikes. The new hammer will cost $490,000. The cost will be depreciated straight-line to zero over the project’s five-year life, at the end of which the new hammer can be scrapped for $40,000. The new hammer will save the firm $146,000 per year in pretax operating costs, and it required an initial investment in net working capital of $35,000. The tax rate of the firm is 30%.
What are the cash flows of firm’s new project (using a time line)?
What is the net present value of this project (list your setups)?
What is the IRR of this project (list your setups)?