A company is looking at setting up a new manufacturing plant.

• This will be a four-year project.
• The company bought some land one years ago for $5 million.
• The land was appraised last month for $5.2 million. In four years, the aftertax value of the land will be $6.2 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 $3,600,000 to build.
• The following is the current market structure:
• Underwriter charges the company spreads of 6 percent on new common stock issues, 4 percent on new preferred stock issues, and 5 percent on new debt issues.
• The company raise the funds needed to build the plant by using common stock, preferred stock, and debt based on the current capital structure.
• The tax rate is 22 percent.
• The project requires $220,000 in initial net working capital investment to get operational.

1. Calculate the projects initial Time 0 cash flow.

2. The new project is somewhat riskier than a typical project for the company. 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 this new project.

3. The manufacturing plant has a five-year tax life, and the company uses straight-line depreciation. At the end of the project, the plant and equipment can be scrapped for $300,000. What is the aftertax salvage value of this plant and equipment? (3 marks)

4. The company will incur $3,300,000 in annual fixed costs. The plan is to manufacture 15,000 products per year and sell them at $1,300 per machine; the variable production costs are $981 per product. What is the annual operating cash flow (OCF) from this project? (3 marks)

5. What is the cash flow in each year? Will you accept the project?

6. If the project is financed solely by debt, would you change your decision in part e? Please explain.

Debt: Common Stock: Preferred Stock: Market: 800 6.5 percent coupon bonds outstanding, 5 years to maturity, selling for 105 percent of par; the bonds have a $1,000 par value each and make quarterly payments. 28,000 shares outstanding, selling for $32 per share; the beta is 1.2. 4,600 shares of 9.0 percent preferred stock outstanding, selling for $102 per share, with par value of $100. 9.3 percent expected market returns; 3 percent risk-free rate. Debt: Common Stock: Preferred Stock: Market: 800 6.5 percent coupon bonds outstanding, 5 years to maturity, selling for 105 percent of par; the bonds have a $1,000 par value each and make quarterly payments. 28,000 shares outstanding, selling for $32 per share; the beta is 1.2. 4,600 shares of 9.0 percent preferred stock outstanding, selling for $102 per share, with par value of $100. 9.3 percent expected market returns; 3 percent risk-free rate