Question

Kirksville Inc. has 1,100 bonds outstanding that are selling for $992 each. The bonds carry a 6.0 percent coupon, pay interest semi-annually, and mature in 7.5 years. The company also has 9,500 shares of 5% preferred stock at a market price of $40 per share. This month, the company paid an annual dividend in the amount of $1.20 per share. The dividend growth rate is 5.0 percent. The common stock is priced at $30 a share and there are 34,500 shares outstanding. The company is considering a project that is equally as risky as the overall company. This project has initial costs of $630,000 and operating cash flows of $80,000 a year for the next 10 years and salvage value of $20,000 at the end of 10 years. The net working capital (NWC) is expected to increase by $10,000 a year until the end of the project life. All the NWCs will be recovered when the project is completed. The project will be depreciated straight-line to zero over the project’s 10-year life. The tax rate is 21%.

1. (15 points) What is Kirksville’s weighted average cost of capital?

WACC = (E/V)R_E + (D/V)R_D (1 – T_C) + (P/V)R_P

             = .41298(.092)+ .4354(.0613468)(1 - .21)+ .151624(.125)

             = 7.8048%

1. 2. (10 points) What is the net present value (NPV) of this project? Should you accept the project? Explain why.
2. 3. (5 points) What is the internal rate of return (IRR) of this project? Should you accept the project if you apply the IRR decision rule?

**Need help with parts b and c**

**Please show all work, explaining steps**

Answer 1

Depreciation = (purchase price - salvage value)/life of equipment = ($630,000 - $20,000)/10 = $610,000/10 = $61,000

After tax salvage value = salvage value*(1-tax rate) = $20,000*(1-0.21) = $20,000*0.79 = $15,800

B P G k L M H A 0 1 Years 1 2 3 4 5 6 7 9 10 Initial cost -$630,000 2 0 0 0 0 0 0 0 0 Operating cash flow Depreciation Pre-tax cash flow $80,000 S0 $80,000 $80,000 $80,000 $80,000 $80,000 $80,000 $80,000 $80,000 $80,000 3 SC $61,000 $61,000 $61,000 $61,000 $61,000 $61,000 $61,000 $61,000 $61,000 $61,000 4 Less: SC $19,000 $19,000 $19,000 $19.000 $19,000 $19.000 $19.000 $19,000 $19,000 $19,000 5 Taxes @21% SO $3,990 $3,990 $3,990 $3,990 $3,990 $3,990 $3,990 $3,990 $3,990 $3,990 6 Less: $15,010 $15,010 $15,010 $15,010 $15,010 $15,010 $15,010 After-tax cash flow $0 $15,010 $61,000 $15,010 $15,010 7 Depreciation NWC required 8 Add back: SC $61,000 $61,000 $61,000 $61.000 $61,000 $61,000 $61,000 $61.000 $61,000 SC $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 9 Less: NWC recovered $0 S0 S0 $0 $0 S0 S0 $0 $0 $0 $100,000 10 Add: Add: $0 SO S0 S0 SO SO S0 S0 SC $15,800 11 Salvage value after tax Net cash flow -$630,000 ($128,524.15) $66.010 $66,010 $66,010 $66,010 $66,010 $66,010 $66.010 $66,010 $66,010 $181,810 12 NPV 13 =NPV (0.078048,D12:M12) +C12 Formula of NPV 14 3.53% 15 IRR 16 Formula of IRR =IRR(C12:M12)

b. NPV of this project is -$128,524.15. You should not accept this project because NPV is negative which means present value of net cash flows is lower than initial investment at required return of 7.8048%. This project will make losses.

c. IRR of this project is 3.53%. You should not accept this project because IRR is lower than required return of 7.8048%. This project will make losses.

Formulas and calculations

A C F H 7 4 10 Years -- .630000 - o. Foting cash fo 80000 80000 80000 80000 80000 80000 - sC$2- 20000- (-$C$2-2000 ( -$c$2-20000 ( -$C$2-20000)/10 E13-14 i80000 80000 80000 80000 epreciatioro = l - SC$2-20000))/1E1-SC$2-200o0-(-sc$2-20000)E(-SC$2-20000)/1-(-SC$2-20000 ( - SC$2-20000)/10 Less: e-tax cash flda Taxes@21%o -D3 - D4 - E3 - E4 = F3 - F4 -G3-G4 -Н3-Н4 = 13 - 14 -К3-К4 = L3 - L4 =M3 - M4 -F5*21% -E5 * 21 % - E5-E6 - E4 H5 * 21 % E 15 21% K5*21 % - L5 21 % =D5 * 21 9% -G5 21 % 15 21 % =15-16 E14 -M5 * 21 % iM5-M6 6 Less: er-tax cash fio 8 Add back:Depreciationo -D5- D6 = F5-F6 -G5-G6 EH5- H6 J5-J6 -K5-K6 7 L5 - L6 H4 M4 G4 -D FA 14 Кл -и 10000 10000 WC require0 Less: 10000 10000 10000 10000 10000 10000 10000 10000 |=sUM(D9 : M9) - 20000* ( 1-0.21) -D7+D8 - D9+ D10+D11 - E7+ E8 -E9+E10+E1- F7+F8-F9+F1 - G7+G8-G9+G10H7+H8-H9+H10 17+18 - 19+ 1 10 =17+ 18 - 19+ J101 = K7+ K8 - K9 + K - L7+L8- L9+ L10 -M7+M8-M9+M10- Add: WC recovere0 ge value afte0 10 0 0 0 Add 0 0 11 0 0. 0. 12 Net cash flow-C2 - NPV ( 0,078048.D12:M12) +C12 13 NPV ormula of NP NPV(0.078048,D12:M12)+C12 IRR(C12:M12) 14 15 IRE ormula of IR - IRR ( C12 : M12) 16