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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 to produce a new line of RDSs. This will be a five-year project. The company bought some land three years ago for $4.5 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. If the land were sold today, the net proceeds would be $5 million after taxes. In five years, the land will be worth $5.3 million after taxes. The company wants to build its new manufacturing plant on this land; the plant will cost $15 million to build. The following market data on DEIs securities are current: Debt: 40,000 6.2 percent coupon bonds outstanding, 25 years to maturity, selling for 95 percent of par; the bonds have a $1,000 par value each and make semiannual payments. Common stock: 825,000 shares outstanding, selling for $97 per share; the beta is 1.25. Preferred stock: 45,000 shares of 5.8 percent preferred stock outstanding, selling for $95 per share. Market: 7 percent expected market risk premium; 3.8 percent risk-free rate. DEIs tax rate is 34 percent. The project requires $825,000 in initial net working capital investment to get operational.

2. DEI uses 7-year MACRS to depreciate the plant to a book value of zero. At the end of the project, the plant can be scrapped for $0.2 million. What is the aftertax salvage value of this manufacturing plant? (10 points) Property Class Year 1 2 3 3-year 33.33% 44.45% 14.81% 7.41% 5-year 20.00% 32.00% 19.20% 11.52% 11.52% 5.76% 4 7-year 14.29% 24.49% 17.49% 12.49% 8.93% 8.92% 8.93% 4.46% 100.00% 5 6 7 8 Total 100.00% 100.00%