Question

Kirksville Inc. has 1,500 bonds outstanding that are selling for $932 each. The bonds carry a 5.0 percent coupon, pay interest semi-annually, and mature in 12.5 years. The company also has 11,500 shares of 6% preferred stock at a market price of $30 per share. This month, the company paid an annual dividend in the amount of $1.50 per share. The dividend growth rate is 4.0 percent. The common stock is priced at $30 a share and there are 35,500 shares outstanding. The company is considering a project that is equally as risky as the overall company. This project has initial costs of $600,000 and operating cash flows of $150,000 a year for the next 10 years and salvage value of $15,000 at the end of 10 years. The initial costs will be financed externally with the flotation costs of 6%. The net working capital (NWC) is expected to increase by $10,000 a year until the end of the project life. The project will be depreciated straight-line to zero over the project’s 10-year life. The tax rate is 20%.

(a) (15 points) What is Kirksville’s weighted average cost of capital?

(b) (10 points) What is the net present value (NPV) of this project? Should you accept the project? Explain why.

Answer 1

	Kirksville Inc
a	Calculation of WACC for the project
	Assuming that the flotaion cost is applicable for all types of capital
	as nothing has been specified .
	Debt :
	YTM = [Annual interest +(Face value-market price)/n]/(Face value +2*market price)/3
	Annual Interest =1000*5%=	50
	Years for Maturity n=	12.5
	Face value	1000
	Realizable Market Price less floatation=932*(1-6%)=	876.08
	Market value of 1500 bonds @932=	1,398,000
	YTM=[50+(1000-876.08)/12.5]/(1000+2*876.08)/3 =
	YTM =6.53%
	Tax rate =20%
	So Post Tax cost of bond =6.53%*80%=	5.22%
	Preferred share
	Realizable Market Price less floatation=30*(1-6%)=	28.2
	Annual dividend	1.5
	Cost of Preferred stock=1.5/28.2=	5.32%
	no of Pref shares outstanding	11500
	Market Value of Preferred shares @30=	345,000
	Equity :
	Market Value of 35500 stock @30=	1,065,000
	P0=30,
	Div growth rate =g=4%
	Floation cost =f=6%
	D0=1.5
	D1=1.5*1.04=1.56
	Cost of Equity=k=[D1/P0(1-f)] +g
	k=1.56/28.2 +4%
	k=5.53% +4%=9.53%
	So cost of equity =9.53%

WACC
Type of capital	Market Value	Weight of Market Value	Post tax cost of Capital	Weighted cost of Capital
Debt	1,398,000	49.79%	5.22%	2.60%
Preferred stock	345,000	12.29%	5.32%	0.65%
Equity	1,065,000	37.93%	9.53%	3.61%
Total	2,808,000	100.00%		6.87%
So WACC for the capital required for the project is 6.87%

	Ans b.
	NPV Calculation	Year 0	PV Factor/ PV annuity factor @6.87%	PV Of Cash flows
	Initial Investment	(600,000)		-
	Increase in NWC	(10,000)		-
a	Total Initian Investment	(610,000)	1	(610,000)
	Cash flow from Operations			-
	Incremental Operating cash flow	150,000
	Depreciation by SL	60,000
	EBT	90,000
	Tax @20%	18,000
	PAT	72,000
	Add back depreciation	60,000
b	Total Operating Cash flow	132,000	7.0660	932,712
	Terminal Cash flow
	Return of NWC	10,000
	Salvage value after tax =15000*80%=	12,000
c	Total Terminal value cash flow	22,000	0.5146	11,321
	TotalPV of all cash flows			334,033
	So NPV of the project is $334,033		jeff jeffy Next > < Previous Related Solutions Kirksville Inc. has 1,500 bonds outstanding that are selling for $932 each. The bonds carry a... Kirksville Inc. has 1,500 bonds outstanding that are selling for $932 each. The bonds carry a 5.0 percent coupon, pay interest semi-annually, and mature in 12.5 years. The company also has 11,500 shares of 6% preferred stock at a market price of $30 per share. This month, the company paid an annual dividend in the amount of $1.50 per share. The dividend growth rate is 4.0 percent. The common stock is priced at $30 a share and there are 35,500... Brownfield Inc. has 1,500 bonds outstanding that are selling for $932 each. The bonds carry a... Brownfield Inc. has 1,500 bonds outstanding that are selling for $932 each. The bonds carry a 5.0 percent coupon, pay interest semi-annually, and mature in 12.5 years. The company also has 11,500 shares of 6% preferred stock at a market price of $30 per share. 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