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 $7.62 million after taxes. In five years, the land will be worth $7.92 million after taxes. The company wants to build its new manufacturing plant on this land; the plant will cost $13.08 million to build. The following market data on Del's securities are current: Debt: 45,200 7 percent coupon bonds outstanding, 22 years to maturity, selling for 94.8 percent of par, the bonds have a $1,000 par value each and make semiannual payments. Common stock: 752,000 shares outstanding, selling for $94.20 per share; the beta is 1.22. Preferred stock: 35,200 shares of 6.3 percent preferred stock outstanding, selling for $92.20 per share. Market: 7.1 percent expected market risk premium; 5.3 percent risk-free rate. DEl's tax rate is 30 percent. The project requires $835,000 in initial net working capital investment to get operational. Calculate the project's Time O cash flow, taking into account all side effects. Assume that any NWC raised does not require floatation costs. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567.) Time O cash flow $ 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 +1 percent to account for this increased riskiness. Calculate the appropriate discount rate to use when evaluating Del's project. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Discount rate The manufacturing plant has an eight-year tax life, and DEl uses straight-line depreciation. At the end of the project (i.e., the end of Year 5), the plant can be scrapped for $1.52 million. What is the aftertax salvage value of this manufacturing plant? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567.) Aftertax salvage value The company will incur $2,320,000 in annual fixed costs. The plan is to manufacture 13,200 RDSs per year and sell them at $10,600 per machine; the variable production costs are $9,800 per RDS. What is the annual operating cash flow, OCF, from this project? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567.) Operating cash flows Calculate the project's net present value. (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Explanation / Answer

Dear Student, Lets take given problem land value today= 7.62 Land value at the end of the project= 7.92 Plant cost 13.08 Debt 7% bonds 22 yesr maturity 45.2 common stock 752000 shares at $ 94.2 per share Beta of the stock 1.22 Preference share 35200 shares 6.3% selling 92.20 per share Rm 7.10% Rf 5.30% Tax Rate 30% Required Working capital $835000 STEP1: COMPUTATION OF PROJECT OUR FLOWS Particulars Amount Opportunity cost of land 7620000 Cost plant 13080000 Working capital 835000 TOTAL CASH OUTFLOWS 21535000 STEP2: Computation of required return under CAPM approach = Rf+ b(Rm-Rf) 5.30+1.22(7.10-5.30) 7.50% STEP3 COMPUTATION OF DEPRECIATION DEPRECIATION PER YEAR = (COST OF PLANT-SALVAGE VALUE)/ LIFE OF PROJECT =(13.08-1.52)/5 2312000 COMPUATION OF SALVAGE VALUE PROFIT ON SALE OF LAND= 300000 SALE PRICE OF PLANT 1520000 WORKING CAPITAL 835000 TOTAL SALVAGE VALUE 2655000 LESS : TAX @ 30% 796500 SALVAGE VALUE AFTER TAX 1858500 STEP4: COMPUTATION OF ANNUAL OPERATING CASH FLOW' PARTICULARS AMOUNT( $ ) SALES = 13200*10600 139920000 LESS: VARIABLE COST 129360000 CONTRIBUTION 10560000 FIXED COST 2320000 OPERATING PROFIT 8240000 STEP 5 COMPUTATION OF NPV A) COMPUTATION OF CASH OUT FLOWS: STEP 1 = 21535000 B) COMPUTATION OF PV OF CASH INFLOWS PARTICULARS YEAR 1-5 OPERATING PROFIT 8240000 LESS : DEPRECIAITON 2312000 LESS: INTEREST ON BONDS 3164000 PBT 2764000 TAX @ 30% 829200 PAT 1934800 LESS: PREFERENCE DIVIDEND 2217600 ADD: DEPRECIATION 2312000 CFAT 2029200 PVAF 7.5 % , 5 YEARS 4.046 PV OF CASH INFLOWS 8210143.2 C) PV OF SALVAGE VALUE= 1858500 D) NPV = B+C-A -11466357

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

---

---

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