Problem $13-24$ Project Evaluation

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 $$4\mathrm{.}4$ million in anticipation of using it as a toxic dump site for waste chemicals, but it built a piping system to safely discard the chemicals instead. The land was appraised last week for $$5\mathrm{.}2$ million on an aftertax basis. In five years, the aftertax value of the land will be $$5\mathrm{.}6$ million, but the company expects to keep the land for a future project. The company wants to build its new manufacturing plant on this land; the plant and equipment will cost $$31\mathrm{.}92$ million to build. The following market data on DEI$$s securities is current:

Debt:

$114,0007$ percent coupon bonds outstanding, $26$ years to maturity, selling for $107$ percent of par; the bonds have a par value of $$2,000$ and make semiannual payments.

Common stock:

$8,700,000$ shares outstanding, selling for $$70\mathrm{.}90$ per share; the beta is $1\mathrm{.}3.$

Preferred stock:

$449,000$ shares of $5\mathrm{.}3$ percent preferred stock outstanding, selling for $$80\mathrm{.}90$ per share; the stock has a par value of $$100.$

Market:

$6$ percent expected market risk premium; $4\mathrm{.}2$ 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, $6$ percent on new preferred stock issues, and $5$ 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. DEI$$s tax rate is $21$ percent. The project requires $$1,275,000$ in initial net working capital investment to get operational. Assume Wharton raises all equity for new projects externally.

a$.$

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. $($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, rounded to the nearest whole number, 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 $1$ percent to account for this increased riskiness. Calculate the appropriate discount rate to use when evaluating DEI$$s project. $($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 $($that is$,$ the end of Year $5),$ the plant and equipment can be scrapped for $$4\mathrm{.}4$ million. What is the aftertax salvage value of this plant and equipment? $($Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole number, e$.$g$.,1,234,567.)$

d$.$ The company will incur $$6,700,000$ in annual fixed costs. The plan is to manufacture $16,500$ RDSs per year and sell them at $$10,750$ per machine; the variable production costs are $$9,350$ per RDS$.$ What is the annual operating 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$.$ DEI$$s comptroller is primarily interested in the impact of DEI$$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? $($Do not round intermediate calculations and round your answer to the nearest whole number, e$.$g$.,32.)$

f$.$ Finally, DEI$$s president wants you to throw all your calculations, assumptions, and everything else into the report for the chief financial officer; all he wants to know is what the RDS project$$s internal rate of return $($IRR$)$ and net present value $($NPV$)$ are. $($Do not round intermediate 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$.,32\mathrm{.}16.)$