That is the market share leader in radar detection systems (RDSs). The company is looking at setting up a manufacturing plant overseas to produce a new line of RDSs. This will be a five-year project. The company bought some land three years ago for $3.7 million in anticipation of using it as a toxic dump site for waste chemicals, but it built a piping system to safely discard the chemicals instead. The land was appraised last week for $4.5 million. In five years, the aftertax value of the land will be $4.9 million, but the company expects to keep the land for a future project. The company wants to build its new manufacturing plant on this land; the plant and equipment will cost $31.36 million to build. The following market data on DEI's securities is current:
Debt:
222,000 7.2 percent coupon bonds outstanding, 25 years to maturity, selling for 108 percent of par; the bonds have a $1,000 par value each and make semiannual payments.
Common stock:
8,000,000 shares outstanding, selling for $70.20 per share; the beta is 1.1.
Preferred stock:
442,000 shares of 5 percent preferred stock outstanding, selling for $80.20 per share and and having a par value of $100.
Market:
7 percent expected market risk premium; 5 percent risk-free rate.
DEI uses G.M. Wharton as its lead underwriter. Wharton charges DEI spreads of 8 percent on new common stock issues, 6 percent on new preferred stock issues, and 4 percent on new debt issues. Wharton has included all direct and indirect issuance costs (along with its profit) in setting these spreads. Wharton has recommended to DEI that it raise the funds needed to build the plant by issuing new shares of common stock. DEI's tax rate is 35 percent. The project requires $1,100,000 in initial net working capital investment to get operational. Assume Wharton raises all equity for new projects externally.
a. Calculate the project's initial Time 0 cash flow, taking into account all side effects. Assume that the net working capital will not require flotation costs. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)
Cash flow $
b. The new RDS project is somewhat riskier than a typical project for DEI, primarily because the plant is being located overseas. Management has told you to use an adjustment factor of +2 percent to account for this increased riskiness. Calculate the appropriate discount rate to use when evaluating DEI's project. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Discount rate %
c. The manufacturing plant has an eight-year tax life, and DEI uses straight-line depreciation. At the end of the project (that is, the end of Year 5), the plant and equipment can be scrapped for $3.7 million. What is the aftertax salvage value of this plant and equipment? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)
Aftertax salvage value $
d. The company will incur $6,000,000 in annual fixed costs. The plan is to manufacture 13,000 RDSs per year and sell them at $10,400 per machine; the variable production costs are $9,000 per RDS. What is the annual operating cash flow (OCF) from this project? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)
Operating cash flow $
e. DEI's comptroller is primarily interested in the impact of DEI's investments on the bottom line of reported accounting statements. What will you tell her is the accounting break-even quantity of RDSs sold for this project? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)
Break-even quantity units
f. Finally, DEI's president wants you to throw all your calculations, assumptions, and everything else into the report for the chief financial officer; all he wants to know is what the RDS project's internal rate of return (IRR) and net present value (NPV) are. Assume that the net working capital will not require flotation costs. (Enter your NPV answer in dollars, not millions of dollars, e.g., 1,234,567. Enter your IRR answer as a percent. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
IRR:
NPV:
This is my excel template from course hero-works great by the way: I don't think I can attach it to make things easier. If there is a way to send it to you then I can do that and it is all filled out.
Input Area:
Land price $3,700,000
Current land value $4,500,000
Land value in 5 years $4,900,000
Plant & Equipment cost $31,360,000
Debt
Bonds outstanding 222,000
Years to Maturity 25
Annual coupon rate 7.20%
Coupons per year 2
Face value (% of par) 1,000.00
Bond price (% of par) 108.00%
Common stock
Shares outstanding 8,000,000
Beta 1.10
Share price $70.20
Preferred stock outstanding
Shares outstanding 442,000
Coupon rate 5.00%
Share price $80.20
Market
Market risk premium 7.00%
Risk-free rate 5.00%
Equity flotation cost 8.00%
Preferred flotation cost 6.00%
Debt flotation cost 4.00%
Tax rate 35%
Net working capital $1,100,000
Does the NWC require
flotation costs (Yes/No) NO
b. Adjustment factor 2%
c. Life of plant (years) 8
Life of project (years) 5
Plant salvage value $3,700,000
d. Annual fixed costs $6,000,000
# RDS manufactured 13,000
Sale price per RDS $10,400
Variable costs per RDS $9,000
Output Area:
Market value of debt $239,760,000 Wd 28.65%
Market value of equity $561,600,000 We 67.11%
Market value of preferred $35,448,400 Wp 4.24%
Market value of firm $836,808,400 Total 100.00%
D/V 28.65%
E/V 67.11%
P/V 4.24%
100.00%
a. flotation costs 6.77%
The cost of the land 3 years ago is a sunk
cost and is irrelevant.
Land $4,500,000
Plant & Equipment Cost 33,636,956
Net working capital 1,100,000
Total Time 0 $33,636,956 This is wrong
b. Pretax cost of debt 6.55%
Aftertax cost of debt 4.25%
Cost of equity 12.70%
Cost of preferred 6.23%
WACC 10.01% WD V $11,760,000
Loss $(8,060,000)
Discount rate for project 12.01% TS $(2,821,000)
c. Book value in year 5
Aftertax salvage value $6,521,000
d. Sales $135,200,000
Variable costs 117,000,000
Fixed costs 6,000,000
Depreciation 3,920,000
EBIT $8,280,000
Taxes 2,898,000
Net income $5,382,000
Depreciation 3,920,000
Operating cash flow $9,302,000
e. Accounting breakeven 7,086
f. Year Cash Flow
0 $(33,636,956)
1 9,302,000
2 9,302,000
3 9,302,000
4 9,302,000
5 21,823,000
IRR 19.06% (these are wrong)
NPV $6,992,123.54
- Comment Flag Question
- Subject: Finance Course: FINC 600$8.00 Deadline Passed
Get notifications through our mobile app when tutors answer your questions.
- 1 Answer
- As stated in our Honor Code, you should never copy these answers as your own. Tutors are here to help you learn how to reach the answer yourself!
- See corrections below;
- Explanation:
- At total time zero
- =33,636,956+4,500,000
- = 38,136,956.00
- IRR
- =IRR(-38,136,956,9,302,000,9,302,000, 9,302,000, 9,302,000,21,823,000,10.01)
- 14%