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8 . Suppose you have been hired as a financial consultant to Defense Electronics, Inc. ( DEI ) , a large, publicly traded firm that
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 fiveyear project. The company bought some land three years ago for $ 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 $ million on an aftertax basis. In five years, the aftertax value of the land will be $ 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 $ million to build. The following market data on DEIs securities is current:
Debt: bonds with a coupon rate of percent outstanding, years to maturity, selling for percent of par; the bonds have a $ par value each and make semiannual payments.
Common stock: shares outstanding, selling for $ per share; the beta is
Preferred stock: shares of percent preferred stock outstanding, selling for $ per share; the stock has a par value of $
Market: percent expected market risk premium; percent riskfree rate.
DEI uses GM Wharton as its lead underwriter. Wharton charges DEI spreads of percent on new common stock issues, percent on new preferred stock issues, and 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 DEI that it raise the funds needed to build the plant by issuing new shares of common stock. DEIs tax rate is percent. The project requires $ million in initial net working capital investment to get operational. Assume DEI raises all equity for new projects externally.
a 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 percent to account for this increased riskiness. Calculate the appropriate discount rate to use when evaluating DEIs project. Hint Estimate the WACC and add
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