Suppose you have been hired as a financial consultant to Defense Electronics, In

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 $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. If the land were sold today, the net proceeds would be $7.7 million after taxes. In five years, the land will be worth $8 million after taxes. The company wants to build its new manufacturing plant on this land; the plant will cost $13.4 million to build. The following market data on DEI’s securities are current: Debt: 46,000 6.8 percent coupon bonds outstanding, 20 years to maturity, selling for 94.0 percent of par; the bonds have a $1,000 par value each and make semiannual payments. Common stock: 760,000 shares outstanding, selling for $95.00 per share; the beta is 1.19. Preferred stock: 36,000 shares of 6.2 percent preferred stock outstanding, selling for $93.00 per share. Market: 7 percent expected market risk premium; 5.2 percent risk-free rate. DEI’s tax rate is 35 percent. The project requires $875,000 in initial net working capital investment to get operational.

Requirement 3: The manufacturing plant has an eight-year tax life, and DEI uses straightline depreciation. At the end of the project (i.e., the end of year 5), the plant can be scrapped for $1.6 million. What is the aftertax salvage value of this manufacturing plant? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567).)

Explanation / Answer

Requirement 3:

Cost of manufacturing Plant = $13400000

Salvage Value = $1600000

Use full Life = 8 years

Method of Depreciation = Straight Line method

Depreciation Per annum = (Cost-salvage value)/Usefull life =(13400000-1600000)/8 =$1475000

Book value at the end of 5th year = Cost-5years Depreciation = $13400000-$8000000 = $5400000

After Tax Salvage value = Cost-Tax(Cost-Book Value) = $13400000-0.35(13400000-5400000) = $10600000

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.