Answered step by step
Verified Expert Solution
Question
1 Approved Answer
Please help with this question. THank you Pretend that you have been hired as a financial consultant to Defense Electronics, Inc. (DEI), a large, publicly
Please help with this question. THank you
Pretend that 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 $3.9 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 $4.1 million on an after-tax basis. In five years, the after-tax value of the land will be $4.4 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 $37 million to build. The following market data on DEl's securities is current: Debt: 205,000 bonds with a coupon rate of 5.8 percent outstanding, 25 years to maturity, selling for 106 percent of par; the bonds have a $1,000 par value each and make semiannual payments. 8,600,000 shares outstanding, selling for $67 per share; the beta is 1.15 . 500,000 shares of 4 percent preferred stock outstanding, selling for $83 per share; the stock has a par value of $100. 7 percent expected market risk premium; 3.1 percent risk-free rate. DEI uses G.M. Wharton as its lead underwriter. Wharton charges DEI spreads of 7 percent on new common stock issues, 5 percent on new preferred stock issues, and 3 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. DEl's tax rate is 25 percent. The project requires $1.5 million in initial net working capital investment to get operational. Assume DEI raises all equity for new projects externally. 1. Calculate the project's initial Year 0 cash flow, taking into account all side effects. Assume that the net working capital will not require flotation costs. 2. 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 +2 percent to account for this increased riskiness. Calculate the appropriate discount rate to use when evaluating DEI's project. 3. The manufacturing plant has an eight-year tax life and DEI uses straight-line depreciation. At the end of the project (i.e., the end of Year 5), the plant and equipment can be scrapped for $4.9 million. What is the aftettax salvage value of this plant and equipment? 4. The company will incur $6.9 million in annual fixed costs. The plan is to manufacture 8,500 RDSs per year and sell them at $13,450 per machine; the variable production costs are $10,600 per RDS. What is the annual operating cash flow (OCF) from this project? 5. DEl'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? 6. Finally, DEl's president wants you to throw all your calculations, assumptions, and everything else into the report for the chief financial officer; all he wants to know is what the RDS project's internal rate of return (IRR) and net present value (NPV) areStep by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started