Problem 12-25 Project Evaluation [LO 3]

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 overseas to produce a new line of RDSs. This will be a five-year project. The company bought some land three years ago for $7.00 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 $7.64 million after taxes. In five years, the land will be worth $7.94 million after taxes. The company wants to build its new manufacturing plant on this land; the plant will cost $13.16 million to build. The following market data on DEI%u2019s securities are current:

Debt:	45,400 7.2 percent coupon bonds outstanding, 18 years to maturity, selling for 94.6 percent of par; the bonds have a $1,000 par value each and make semiannual payments.
Common stock:	754,000 shares outstanding, selling for $94.4 per share; the beta is 1.24.
Preferred stock:	35,400 shares of 6.40 percent preferred stock outstanding, selling for $92.4 per share.
Market:	7.20 percent expected market risk premium; 5.40 percent risk-free rate.

DEI%u2019s tax rate is 40 percent. The project requires $845,000 in initial net working capital investment to get operational.

Requirement 1:

Calculate the project%u2019s Time 0 cash flow, taking into account all side effects. Assume that any NWC raised does not require floatation costs. (Do not include the dollar sign ($). Negative amount should be indicated by a minus sign. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567).)

Initial time 0 cash flow

$

Requirement 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 +3 percent to account for this increased riskiness. Calculate the appropriate discount rate to use when evaluating DEI%u2019s project.(Do not include the percent sign (%). Round your answer to 2 decimal places (e.g., 32.16).)

Discount rate

%

Requirement 3:

The manufacturing plant has an eight-year tax life, and DEI uses straightline depreciation. At the end of the project (i.e., the end of year 5), the plant can be scrapped for $1.54 million. What is the aftertax salvage value of this manufacturing plant? (Do not include the dollar sign ($). Enter your answer in dollars, not millions of dollars (e.g., 1,234,567).)

Aftertax salvage value

$

Requirement 4:

The company will incur $2,340,000 in annual fixed costs. The plan is to manufacture 13,400 RDSs per year and sell them at $10,800 per machine; the variable production costs are $10,000 per RDS. What is the annual operating cash flow, OCF, from this project? (Do not include the dollar sign ($). Enter your answer in dollars, not millions of dollars (e.g., 1,234,567).)

Operating cash flow

$

Requirement 5:
(a)	Calculate the net present value. (Do not include the dollar sign ($). Round your answer to 2 decimal places (e.g., 32.16).)

Net present value

$

(b)	Calculate the internal rate of return. (Do not include the percent sign (%). Round your answer to 2 decimal places (e.g., 32.16).)

Internal rate of return

%