Problem $12-28$ Project Evaluation $[$LO $3]$

Suppose you have been hired as a financial consultant to Defense Electronics, Incorporated $($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 five$-$year project. The company bought some land three years ago for $$7\mathrm{.}3$ 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 $$7\mathrm{.}75$

million after taxes. In five years, the land will be worth $$8\mathrm{.}05$ million after taxes. The company

wants to build its new manufacturing plant on this land; the plant will cost $$13\mathrm{.}6$ million to build.

The following market data on DEl's securities are current:

DEl's tax rate is $25$ percent. The project requires $$900,000$ in initial net working capital

investment to get operational.

a$.$ Calculate the project's Time $0$ cash flow, taking into account all side effects. Assume that any

NWC raised does not require floatation costs.

Note: A negative answer should be indicated by a minus sign. Do not round intermediate

calculations and enter your answer in dollars, not millions of dollars, e$.$g$.,1,234,567.$

b$.$ 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 $+3$

percent to account for this increased riskiness. Calculate the appropriate discount rate to use

when evaluating DEl's project.

Note: Do not round intermediate calculations and enter your answer as a percent rounded

to $2$ decimal places, e$.$g$.,32\mathrm{.}16.$

c$.$ 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 can be scrapped for $$1\mathrm{.}65$ million. What

is the aftertax salvage value of this manufacturing plant?

Note: Do not round intermediate calculations and enter your answer in dollars, not millions

of dollars, e$.$g$.,1,234,567.$

d$.$ The company will incur $$2,450,000$ in annual fixed costs. The plan is to manufacture $14,500$

RDSs per year and sell them at $$11,900$ per machine; the variable production costs are $$11,100$

per RDS$.$ What is the annual operating cash flow, OCF, from this project?

Note: Do not round intermediate calculations and enter your answer in dollars, not millions

of dollars, e$.$g$.,1,234,567.$

e$.$ Calculate the project's net present value.

Note: Do not round intermediate calculations and enter your answer in dollars, not millions

of dollars, rounded to $2$ decimal places, e$.$g$.,1,234,567\mathrm{.}89$

f$.$ Calculate the project's internal rate of return.

Note: Do not round intermediate calculations and enter your answer as a percent rounded

to $2$ decimal places, e$.$g$.,32\mathrm{.}16.$

Answer is complete but not entirely correct.Suppose you have been hired as a financial consultant to Defense Electronics, Incorporated $($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 five$-$year project. The company bought some land three years ago for $$7\mathrm{.}3$ million in anticipation of using it as a toxic dump site for waste chemicals, but it built a piping system to safely discard the chemicals instead. If the land were sold today, the net proceeds would be $$7\mathrm{.}75$ million after taxes. In five years, the land will be worth $$8\mathrm{.}05$ million after taxes. The company wants to build its new manufacturing plant on this land; the plant will cost $$13\mathrm{.}6$ million to build. The following market data on DEI$$s securities are current:

Debt: $93,0006\mathrm{.}8$ percent coupon bonds outstanding, $27$ years to maturity, selling for $93\mathrm{.}5$ percent of par; the bonds have a $$1,000$ par value each and make semiannual payments.

Common stock: $1,780,000$ shares outstanding, selling for $$95\mathrm{.}50$ per share; the beta is $1\mathrm{.}14.$

Preferred stock: $84,000$ shares of $6\mathrm{.}2$ percent preferred stock outstanding, selling for $$93\mathrm{.}50$ per share.

Market: $6\mathrm{.}9$ percent expected market risk premium; $4\mathrm{.}85$ percent risk$-$free rate.

DEI$$s tax rate is $25$ percent. The project requires $$900,000$ in initial net working capital investment to get operational.