Flotation Costs and NPV Photochronograph Creative (PC) manufactures time series photographic equipment. It is currently at its
Question:
Flotation Costs and NPV Photochronograph Creative
(PC) manufactures time series photographic equipment. It is currently at its target debt–equity ratio of 0.70. It is considering building a new £45 million manufacturing facility. This new plant is expected to generate after-tax cash flows of £6.2 million in perpetuity. The company raises all equity from outside financing. There are three financing options:
(a) A new issue of equity. The flotation costs of the new equity would be 8 per cent of the amount raised. The required return on the company’s new equity is 14 per cent.
(b) A new issue of 20-year bonds. The flotation costs of the new bonds would be 4 per cent of the proceeds. If the company issues these new bonds at an annual coupon rate of 8 per cent, they will sell at par.
(c) Increased use of accounts payable financing. Because this financing is part of the company’s ongoing daily business, it has no flotation costs, and 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 0.20. (Assume there is no difference between the pre-tax and after-tax accounts payable cost.)
What is the NPV of the new plant? Assume that PC has a 28 per cent tax rate.
Step by Step Answer:
Fundamentals Of Corporate Finance
ISBN: 9780077178239
3rd Edition
Authors: David Hillier, Iain Clacher, Stephen A. Ross