10.00 points Suppose you have been hired as a financial consultant to Defense El
ID: 2796180 • Letter: 1
Question
10.00 points 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 $5.5 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 $6.3 million. In five years, the aftertax value of the land will be $6.7 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 S32.80 million to build. The following market data on DEI's securities are current Debt 240,000 7.4 percent coupon bonds outstanding, 25 years to maturity, selling for 107 percent of par; the bonds have a $1,000 par value each and make semiannual Common stock: 9,800,000 shares outstanding, selling for S71.90 per share; the beta is 1.2. Preferred stock: 460,000 shares of 6 percent preferred stock outstanding, selling for $82.00 per share. Market 8 percent expected market risk premium; 6 percent risk-free rate. DEI uses G.M. Wharton as its lead underwriter. Wharton charges DEl spreads of 9 percent on new common stock issues, 7 percent on new preferred stock issues, and 5 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 DEl that it raise the funds needed to build the plant by issuing new shares of common stock. DEI's tax rate is 38 percent. The project requires $1,550,000 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.. a. Calculate the project's initial time 0 cash fow, taking into account all side effects. (Negative amount should be indicated by a minus sign. Enter your answer in dollars, not millions of dollars, l.e 1,234,567. Do not round intermediate calculations and round your final answer to the nearest whole dollar amount.) Cash flow b. The new RDS project is somewhat riskier than a typical project for DEI, primarily because the plant s 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. (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16) Discount rate c. The manufacturing plant has an eight-year tax life, and DEl 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 $5.5 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.) Aftertax salvage value d. The company will incur $7,800,000 in annual fixed costs. The plan is to manufacture 22,000 RDSs per year and sell them at $11,300 per machine; the variable production costs are $9,900 per RDS. What is the annual operating cash fow (OCF) from this project? (Enter your answer in dollars, not millions of dollars, .e. 1,234,567.) Operating cash flow e. DEI's comptroller is primarily interested in the impact of DEl'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.) Break-even quantity f. Finally, DEl's president wants you to throw all your calculations, assumptions, and everything else nto the report for the chief financial officer, al 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, .e. 1,234,567. Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16)) IRR NPVExplanation / Answer
a
Project's Initial cashflow will be = Cost of equipment + Working capital = -$32,800,000 - $1,550,000 = -$34350000
Cost of land is a sunk cost and will not be included in project analysis
b
WACC = Cost of Equity * (Market Value of Equity/Total Value) + Cost of debt * (1- tax rate) * Market Value of Debt/ Total value
Cost of Equity = Riskfree rate + (Beta * Market risk premium) = 6% + 1.2 * 8% = 15.6%
WACC = 15.6% * $37720000/$63400000 + 7.4% *(1-38%) * $25680000/$63400000 = 11.14%
Adjustment of 3% to WACC = 11.14% + 3% = 14.14%
c
Annual depreciation of Plant & Equipment = Cost of Plant & Equipment / Life of plant & Equipment = $32800000/8 = $4100000
After tax Salvage Value of P&E = Salvage value - ( Salvage Value - Undepreciated value) * tax rate
= $5500000 - ($5500000 - $12300000)* 0.38 = $8084000
d
OCF = (Cash inflow/Revenues - Cash Outflows/expenses -Depreciation) * (1-tax rate) + Depreciation
= ( $11300 * 22000 - $7800000 - $9900 * 22000 - $4100000) (1- 0.38) + $4100000
= $15818000
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.