Kimoto Ltd has designed a new product and conducted a market survey costing $30,000 to assess its viability. The survey has determined that the new product will generate sales of $1,200,000 per year. Fixed costs associated with the product will be $50,000 a year and variable costs will amount to 35% of sales. The equipment necessary for production will cost $1,500,000 and is to be depreciated evenly over the project’s life of 5 years (straight-line method). In addition, $45,000 in net working capital is required to fund the project. The tax rate is 30%. The company believes the risk of the new project is the same as the risk of the company’s existing assets. Kimoto’s capital consists of the following : Ordinary Shares: The company has 2 million ordinary shares outstanding, currently selling for $150 per share and a beta of 1.2. The market risk premium (rm-rf) is 8% and the risk-free rate is 3%. Preference Shares: The company has 1 million preference shares, currently selling for $85 and paying an $8 dividend. Bonds: The company has 120,000 bonds outstanding that mature in 4 years with an annual coupon of 8%, making half-yearly payments. The bonds have a face value of $1,000 and currently sell in the market for $960. Therefore, the annual YTM is 9.2%. (a)Calculate Kimoto’s weighted average cost of capital (WACC) (b)Using the NPV criterion, should the project go ahead?

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter14: Capital Structure Management In Practice

Section14.A: Breakeven Analysis

Problem 8P

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Kimoto Ltd has designed a new product and conducted a market survey costing $30,000 to assess its viability. The survey has determined that the new product will generate sales of $1,200,000 per year. Fixed costs associated with the product will be $50,000 a year and variable costs will amount to 35% of sales. The equipment necessary for production will cost $1,500,000 and is to be depreciated evenly over the project’s life of 5 years (straight-line method). In addition, $45,000 in net working capital is required to fund the project. The tax rate is 30%.

The company believes the risk of the new project is the same as the risk of the company’s existing assets.

Kimoto’s capital consists of the following :

Ordinary Shares:

The company has 2 million ordinary shares outstanding, currently selling for $150 per share and a beta of 1.2.
The market risk premium (rm-rf) is 8% and the risk-free rate is 3%.

Preference Shares:

The company has 1 million preference shares, currently selling for $85 and paying an $8 dividend.

Bonds:

The company has 120,000 bonds outstanding that mature in 4 years with an annual coupon of 8%, making half-yearly payments. The bonds have a face value of $1,000 and currently sell in the market for $960. Therefore, the annual YTM is 9.2%.

(a)Calculate Kimoto’s weighted average cost of capital (WACC)

(b)Using the NPV criterion, should the project go ahead?

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