Project Evaluation (L03, 4) This is a comprehensive project evaluation problem bringing together much of what you have learned in this and previous chapters. Suppose you have been hired as a financial consultant to Defence Electronics Inc. (DEI), a large, publicly traded firm that is the market share leader in radar detection systems (F1085). The company is looking at setting up a manufacturing plant overseas to produce a newline of FlDSs. This will be a fiveyear project. The company bought some land three years ago for $3.9 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 lor $4.4 million on an aftertax basis. In live years, the aiter-tax value of the land will be $4.8 million, but the company expects to keep the land tor a future project. The company wants to build its new manuiacturing plant on this land; the plant will cost $37 million to build. The following market data on DEI's securities are current: Page 553 Debt: 210,000 6.4 percent coupon bends outstanding, 25 years to maturity, selling for 108 percent of par; the bonds have a $1,000 par value each and make semiannual payments Common stock: 8,300,000 shares outstanding, selling for $58 per share; the beta is 1.1 Preferred stock: 450,000 shares oi 4.5 percent preferred stock outstanding, selling for $81 per share Market: 7 percent expected market risk premium; 3.5 percent riskfree rate DEI uses GM. Wharton as its lead underwriter. Wharton charges DEI spreads of 8 percent on new common stock issues, 6 percent on new preferred stock issues, and 4 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 lunds needed to build the plant by issuing new shares of common stock. DEI's tax rate is 35 percent. The project requires $1,300,000 in initial net working capital investment to get operational. Assume Wharton raises all equity for new projects externally. 1 Calculate the project's initial Time 0 cash flow, taking into account all side effects. 1 The new EDS 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 12 percent to account for this increased riskiness. Calculate the appropriate discount rate to use when evaluating DEI's project. 1 The manufacturing plant belongs to CCA Class 43 (30%). At the end of the project (that is, the end of Year 5), the plant can be scrapped for $5.1 million. What is the PVCCATS of this plant and equipment? 1 The company will incur $6,700,000 in annual fixed costs. The plan is to manufacture 15,300 FiDSs per year and sell them at $1 1,450 per machine; the variable production costs are $9,500 per RDS. What is the annual operating cash flow (OCF) from this project? 1 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 breakeven quantity oi RDSs sold for this project
