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QUESTION 1
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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 but decides NOT to
recoup the net working capital at the end of the investment
project. 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 131.472% 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%.
Use the above information to answer Questions 1 - 17.
How much money does KHC need to spend to start the
investment project (i.e., project cash flow at time 0)?
a. $2,530,000
$30,000
$1,030,000
.$2,030,000
QUESTION 2
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Should KHC include consulting fee, $50,000, in estimating
project's cash flows?
a. Yes.
b. No.
QUESTION 3
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Should KHC include interest expenses, $45,000, in estimating
project's cash flows?
a. No.
b. Yes.
QUESTION 4
2 points
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What is the annual project cash flow expected to be generated
from the investment project (i.e., project cash flow at time 1 -
10)?
a. $137,500
b. $100,000
c. $297,500
d.$171,250
QUESTION 5
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What is the cost of preferred stock for KHC?
a. 6.25
b.16
c.6.25%
d. 16%
QUESTION 6
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What is the after-tax cost of debt for KHC?
a. 5%
b.3%
c. 4%
d.2%
QUESTION 7
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What is the cost of equity for KHC by using the capital asset
pricing model?
a. 12.9%
b. 15.4%
c. 14.1%
d.10.2%
QUESTION 8
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What is the cost of equity for KHC by using the dividend growth
model?
a. 12.7%
b. 10.2%
C. 9.5%
d.13.1%
QUESTION 9
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What is KHC's market value capital structure?
a. $10,517,760
b. $17,360,000
c. $1,080,000
d. $28,957,760
QUESTION 10
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What is the weighted average cost of capital for KHC?
a. 15%
b.12%
6%
d.9%
QUESTION 11
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What is the payback period for the investment project?
a. 6.82 years
b. 7.86 years
c. 5.21 years
d.6.01 years
QUESTION 12
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What is the net present value for the investment project?
a. $33,619.42
b.-$120,645.72
c.-$25,278.31
d. $69,023.88
QUESTION 13
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What is the internal rate of return for the investment project?
a. 11.3%
b.8.6%
c. 10.5%
1.9.4%
QUESTION 14
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What is the profitability index for the project?
a. -0.98
b. 1.07
c.-1.07
d.0.98
QUESTION 15
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Should KHC accept the project?
a. Yes because the payback period is longer than the project life.
b. Yes because the net present value is positive.
c. No because the profitability index is negative.
d. No because the internal rate of return is higher than the cost of capital.
QUESTION 16
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What is the maximum price that KHC has to pay if the target
profitability index is 1.2?
a. $915,853.23
b. $1,735,777.27
c. $999,112.62
d. $1,982,439.50
QUESTION 17
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What is the minimum annual cash flow that project has to
generate in order to accept the project?
a. $329,597.61
b. $316,297.91
C. $160,494.69
d. $145,396.85

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