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 $7.79 million after taxes. In five years, the land will be worth $8.09 million after taxes. The company wants to build its new manufacturing plant on this land; the plant will cost $13.76 million to build. The following market data on DEI's securities are current: Debt: 46,900 7.2 percent coupon bonds outstanding, 18 years to maturity, selling for 93.1 percent of par; the bonds have a $1,000 par value each and make semiannual payments. Common stock: 769,000 shares outstanding, selling for $95.90 per share; the beta is 1.10. Preferred stock: 36,900 shares of 6.4 percent preferred stock outstanding, selling for $93.90 per share. Market: 7.2 percent expected market risk premium; 5.4 percent risk-free rate. DEI's tax rate is 40 percent. The project requires $920, 000 in initial net working capital investment to get operational. Requirement 1: Calculate the project's Time 0 cash flow, taking into account all side effects. Assume that any NWC raised does not require floatation costs. Initial Time 0 cash flow Requirement 2: 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 +3 percent to account for this increased riskiness. Calculate the appropriate discount rate to use when evaluating DEI's project. Discount rate

Explanation / Answer

As per chegg I am answering first four answers:

Answer 1 Land's current value $                     7.79 mn Plant cost $                   13.76 mn Initial working capital requirement $                     0.92 mn Initial cash flow $                   22.47 mn Answer 2 Market value of equity 46900*1000*.931 $ 43,663,900.00 Market value of debt 76900*95.9 $    7,374,710.00 Market value of preferred stock 36900*93.9 $    3,464,910.00 Total Market value of the company Market value of debt+Market value of equity+Market value pf preferred stock 43663900+7374710+3464910 $ 54,503,520.00 Cost of Equity Risk Free return+Beta*(Market rate of return-Risk free rate of return) .054+1.10(.072) 0.1332 Cost of Debt Cost of Debt is YTM 931=$36(PVIFAR%,36)+$1,000(PVIFR%,30) 3.96% YTM 3.96%*2 0.0792 7.92% Cost of Debt after tax (1-.40).0792 0.04752 4.75% Cost of Preferred Stock 6.4/93.90 0.068157614 6.81% WACC (Market value of equity/Market value of Company)*Cost of Equity+(Market value of debt/Market value of company)*cost of debt+(Market value of preferred stock/Market value of company)*Cost of preferred stock (43663900/54503520)*.1330+(7374710/54503520)*.0475+(3464910/54503520)*.0681 0.117305411 Adjustment factor 3% .03 will be added in WACC 0.147305411 14.73% Answer 3 Annual Depreciation 13.76/8 1.72 =1720000 Book value at the end of 5 years 13.76-5(1.72) 5.16 =5160000 Answer 4 Operating cash flow Selling value per machine-Varable production cost)No. of machine manufactured-Fixed Cost(1-tax rate)+tax rate*Depreciation per year {(12300-11500)14900-2490000}(1-.40)+.40*1720000 =6346000

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