Suppose you have been hired as a financial consultant to Defense Electronics, In
ID: 2682333 • Letter: S
Question
Suppose you have been hired as a financial consultant to Defense Electronics, Inc. (DEI), a large, publicly traded firm 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 $6 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 $7.8 million. In five years, the aftertax value of the land will be $8 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 $12.8 million to build. The following market data on DEI
Suppose you have been hired as a financial consultant to Defense Electronics, Inc. (DEI), a large, publicly traded firm 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 $6 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 $7.8 million. In five years, the aftertax value of the land will be $8 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 $12.8 million to build. The following market data on DEI
Explanation / Answer
Cost of Equity=Riskfree rate+Risk premium X beta. Cost = 3.5+6.5X1.2 = 11.3%. The market value is 264,000 X 76=$20.064 million. In CAPM we cannot adjust for the floatation cost. We now find the WACC. The total market value is 11.160+1.15.
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