WACC and NPV Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target
Question:
WACC and NPV Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt–equity ratio of 1.3. It’s considering building a new $45 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $5.7 million in perpetuity. There are three financing options:
• A new issue of common stock. The required return on the company’s equity is 17 percent.
• A new issue of 20-year bonds. If the company issues these new bonds at an annual coupon rate of 9 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 .20. (Assume there is no difference between the pretax and aftertax accounts payable cost.)
What is the NPV of the new plant? Assume that PC has a 35 percent tax rate. LO.1
Step by Step Answer: