4. Photochronograph Corporation (PC) manufactures time series photographic equip

Question

4.

Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt-equity ratio of .68. It’s considering building a new $65.8 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $7.83 million in perpetuity. There are three financing options:

A new issue of common stock: The required return on the company’s new equity is 15 percent.

A new issue of 20-year bonds: If the company issues these new bonds at an annual coupon rate of 7.3 percent, they will sell at par.

Increased use of accounts payable financing: Because this financing is part of the company’s ongoing daily business, the company assigns it a cost that is the same as the overall firm WACC. Management has a target ratio of accounts payable to long-term debt of .13. (Assume there is no difference between the pretax and aftertax accounts payable cost.)

If the tax rate is 38 percent, what is the NPV of the new plant? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567). Round your answer to 2 decimal places (e.g., 32.16).)

Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt-equity ratio of .68. It’s considering building a new $65.8 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $7.83 million in perpetuity. There are three financing options:

Explanation / Answer

Calculation of WACC

Cost of Equity = 15%

Cost of Debt = 7.3 (1-0.38) = 4.526%

Cost of accounts payable = X%

WACC = [Cost of equity x weight of equity] + [Cost of debt x weight of debt] + [Cost of accounts payable x weight of accounts payable]

X = [15 x 0.32] + [4.526 x 0.55] + [X x 0.13]

X = 7.2893 + 0.13X

X = 8.38%

WACC = 8.38%

Present Value of Cash inflows = 7830000 / 0.0838

= $93436754

NPV = Present Value of Cash inflows - Present Value of Cash ouflows

= 93436754 - 65800000

= $27636754

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