Suppose you have been hired as a financial consultant to Defense Electronics, In
ID: 2718784 • 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 $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 are current:
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.
8,000,000 shares outstanding, selling for $70.20 per share; the beta is 1.1.
442,000 shares of 5 percent preferred stock outstanding, selling for $80.20 per share.
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 and that the NWC does not require floatation costs..
Calculate the project’s initial time 0 cash flow, taking into account all side effects. (Negative amount should be indicated by a minus sign. Enter your answer in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations and round your final answer to the nearest whole dollar amount.)
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 and round your final answer to 2 decimal places. (e.g., 32.16))
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? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations.)
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? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567.)
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 final answer to nearest whole number.)
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. (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))
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.
Market:7 percent expected market risk premium; 5 percent risk-free rate.
Explanation / Answer
Ans
Ans 1 Oppurtunity Cost of Land 45,00,000.00 Cost of Plant and Equipment 313,60,000.00 Initial Capital Cost 358,60,000.00 Working Capital Investment 11,00,000.00 Net Initial Cost 369,60,000.00 Ans 2 Marginal cost of capital Funding is through external Equity Rf+(Rm-Rf)*beta 5+(7*1.1) 12.70% Risk adjusted discount rate=Marginal Cost of capital+2% 14.700% Ans 3 Scrap Value of Plant 37,00,000.00 Net Book Value of the Plant after tax dep 117,60,000.00 Loss -80,60,000.00 Tax -28,21,000.00 After Tax Value 8,79,000.00 Ans 4 Sales 1352,00,000.00 Less Variable cost 1170,00,000.00 Less Fixed cost 60,00,000.00 Total Cost 1230,00,000.00 122,00,000.00 Less Depreciation 39,20,000.00 Profit Before Tax 82,80,000.00 Less tax 28,98,000.00 Profit After tax 53,82,000.00 Add:Depreciation 39,20,000.00 Operating cash flows 93,02,000.00 Ans 5 Profit After tax 53,82,000.00 Initial Cost Land acquisition cost 37,00,000.00 Plant 313,60,000.00 Operating Fixed cost 300,00,000.00 Total Fixed cost 650,60,000.00 Less Scrap Value of Plant -37,00,000.00 Total Cost 613,60,000.00 Conribution Per unit=10400-9000 1400 No of units to be sold 43,828.57Related Questions
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