Problem $13-24$ Project Evaluation

Suppose you have been hired os a financial consultant to Defense Electronics,

Incorporsted $($DEI$),$ a large, publicly troded firm that is the market share lesder in rodor

detection systems $($RDSs$).$ The compony is looking ot setting up a manufacturing plant

oversess to produce a new line of RDSs$.$ This will be o five$-$yeor project. The compony

bought some land three years ago for $$4\mathrm{.}9$ million in anticipation of using it ss a toxic

dump site for waste chemicals, but it built o piping system to sofely discard the

chemicals instead. The land wos opproised last week for $$5\mathrm{.}7$ million on an aftertax

bosis. In five years, the oftertox volue of the land will be $$6\mathrm{.}1$ million, but the compony

expects to keep the land for o future project. The company wants to build its new

manufacturing plant on this land; the plant and equipment will cost $$32\mathrm{.}32$ million to

build. The following market dato on DEl's securities is current:

Debt

$117,0007\mathrm{.}4$ percent coupon bonds outstanding, $25$ years to maturity.

selling for $109$ percent of par; the bonds have o por volue of $$2,000$ and

make semiannual payments.

Common $9,200,000$ sheres outstanding, selling for $$71\mathrm{.}40$ per share; the beto is

stock $,1\mathrm{.}2$

Preferred $454,000$ shares of $4\mathrm{.}6$ percent preferred stock outstanding, selling for

stock. $$81\mathrm{.}40$ per share; the stock has a por value of $$100.$

Morket. $8$ percent expected market risk premium; $3\mathrm{.}5$ percent risk$-$free rate.

DEl uses G$.$M$.$ Wharton as its lead undenwriter. Wharton charges DEl spreads of $7\mathrm{.}5$

percent on new common stock issues, $6\mathrm{.}5$ percent on new preferred stock issues, and

$5\mathrm{.}5$ percent on new debt issues. Wharton has included all direct and indirect issuance

costs $($slong with its profit$)$ in setting these spresds. Wharton has recommended to DEI

thst it raise the funds needed to build the plant by issuing new shores of common stock.

DEl's tox rote is $24$ percent. The project requires $$1,400,000$ in initial net working copital

investment to get operational. Assume Wharton raises all equity for new projects

externally.

a$.$ Colculate the project's initiol Yeor $0$ cosh flow, taking into occount all side effects.

Assume that the net working capital will not require flotation costs. $($A negatlve

answer should be Indicated by a minus sign. Do not round Intermedlate

calculations and enter your answer In dollars, not millions of dollars, rounded to

the nearest whole number, e$.$g$..1,234,567.)$

b$.$ The new RDS project is somewhat riskier than a typical project for DEl, primerily

becouse the plant is being located overseas. Mansgement has told you to use on

acjustment factor of $3$ percent to account for this incressed riskiness. Calculate the

sppropriate discount rate to use when evaluating DEl's project. $($Do not round

intermediate calculations and enter your answer as a percent rounded to $2$ decimal

places, e$.$g$.,3216.)$

c$.$ The manufacturing plant has on eight$-$yeor tox life, and DEl uses straight$-$line

depreciation. At the end of the project $($that is$,$ the end of Year $5),$ the plant and

equipment can be scrapped for $$4\mathrm{.}9$ million. What is the aftertax salvoge volue of this

plent and equipment? $($Do not round Intermedlate calculations and enter your

answer in dollars, not millions of dollars, rounded to the nearest whole number,

e$.$g$.,1,234,567.)$

d$.$ The company will incur $$7,200,000$ in annusl fixed costs. The plan is to manufacture

$19,000$ RDSs per year and sell them at $$11,000$ per machine; the variable production

costs are $$9,600$ per RDS$.$ What is the annusl opersting cash flow $($OCF$)$ from this

project? $($Do not round intermediate calculations and enter your answer in dollars,

not millions of dollars, rounded to the nearest whole number, e$.$g$.,1,234,567.)$

e$.$ DEl's comptroller is primerily interested in the impoct of DEl's investments on the

bottom line of reported sccounting statements. What will you tell her is the sccounting

bresk$-$even quantity of RDSs sold for this project? $($Do not round Intermediate

calculations and round your answer to the nearest whole number, e$.$g$..32)$

f$.$ Finally, DEl's president wants you to throw all your calculations, ossumptions, and

everything else into the report for the chief finsencisl officer; all he wonts to know is

what the RDS project's internal rate of return $($IRR$)$ and net present value $($NPV$)$ are.

$($Do not round Intermedlate calculations. Enter your NPV answer In dollars, not

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

answer as a percent rounded to $2$ decimal places, e$.$g$.,3216.)$