Suppose you have been hired as a financial consultant to Applied Nanotech Enterprises, (ANE). The company is looking at setting up manufacturing plant overseas to produce a new surface-cleaning machine. This will be a five-year project. The company bought some land three years ago for $8.5 million. The land was appraised last week for $7.1 million. In five years, the after -tax value of the land will be $7.4 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 $40 million to build.

The following market data on ANEs securities are current:

Debt: 260,000 6.8% coupon bonds outstanding, 25 years to maturity, selling for 103% of par; the bonds have a $1,000 par value each and make semi-annual payments.

Common stock: 9,500,000 shares outstanding selling for $67 per share; the beta 1.25.

Preferred stock: 450,000 shares of 5.25% preferred stock outstanding, selling for $84 per share and having a par value of $100.

Market: 7% expected market risk premium; 3.6%risk-free rate.

ANE uses Desjardins as its lead underwriter. Desjardins charges ANE spreads of 6.5% on new common stock issues, 4.5% on new preferred stock issues, and 3% on new debt issues. ANEs tax rate is 35%. The project requires $1,400,000 in initial net working capital to get operational. 2

Required:

a) Calculate the projects initial time 0 cash flow, taking into account all side effects.

b) The new surface-cleaning machine project is somewhat riskier than a typical project for ANE, primarily because the plant is being located overseas. Management has told you to use an adjustment factor of +2 percent to account for this increases riskiness. Calculate the appropriate discount rate to use when evaluating ANEs project.

c) The manufacturing plant has an eight-year tax life, and ANE 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 $8.5 million. What is the after -tax salvage value of this plant and equipment?

d) The company will incur $7,900,000 in annual fixed costs. The plan is to manufacture 18,000 surface-cleaning machines per year and sell them at $10,900 per machine; the variable production costs are $9,450 per machine. What is the annual operating cash flow (OCF)from this project?

e) What are the NPV and IRR of the project? What will you report?