Suppose you have been hired as a financial consultant to DE Ltd, a large, publicly traded firm that is the market share leader in radar detection systems (RDSs). DEI’s tax rate is 34 per cent. You have the following market data on DEI’s securities: Debt: 46,600 6.9 per cent coupon bonds outstanding, 21 years to maturity, selling for 93.4 per cent of par; the bonds have a $1000 par value each and make semi-annual payments. Common stock: 766,000 shares outstanding, selling for $95.60 per share; the beta is 1.13. Preferred stock: 36,600 shares paying a fixed dividend of $6.25 per preference share, selling for $93.60 per share. Market: 7.05 per cent expected market risk premium; 5.25 per cent risk-free rate. 

Requirement 1- Calculate the firm’s before tax and after-tax cost of debt, cost of preferred shares and the cost of ordinary shares. 

Requirement 2- Calculate the firm’s weighted average cost of capital (use the market values when calculating the weights). 

Requirement 3- The company is looking at setting up a manufacturing plant overseas to produce a new line of RDSs. The new project would cost $1.7 million and is expected to provide $200,000 of cashflow at the end of each year forever. The project is, however, 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 per cent to account for this increased riskiness. 

a) What is the appropriate discount rate to use when evaluating DEI’s project? 

b. Use this discount rate (that you calculated in part a) to estimate the net present value of the project. Should the firm accept the project? 

c. Discuss whether your decision would have been different if you have used the company’s overall WACC (unadjusted for project’s higher risk) when discounting the projects cashflows in your NPV calculation.