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Suppose you have been hired as a financial consultant to Defense Electronics, Incorporated ( DEl ) , a large, publicly traded firm that is the

Suppose you have been hired as a financial consultant to Defense Electronics,
Incorporated (DEl), 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 $3.7 million in anticlpation 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 appralsed last week for $6.7 million on an aftertax basis. In five
years, the aftertax value of the land will be $7.2 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 $33.4 million to bulld. The following market
data on DEl's securitles are current:
Debt: ,285,000 bonds with a coupon rate of 6.8 percent outstanding. 26 years
to maturlty, selling for 108 percent of par; the bonds have a $1,000 par
value each and make semlannual payments.
Common ,10,300,000 shares outstanding, selling for $75.50 per share; the beta is
stock: ,1.2
Preferred 505.000 shares of 4.6 percent preferred stock outstanding. selling for
stock: ,$85.00 per share. The par value is $100.
Market: ,6.8 percent expected market rlsk premlum; 3.7 percent rlsk-free rate.
DEl uses G.M. Wharton as its lead underwriter. Wharton charges DEl spreads of 6.5
percent on new common stock Issues, 4 percent on new preferred stock Issues, and 2
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
ralse the funds needed to build the plant by Issulng new shares of common stock. DEI's
tax rate is 25 percent. The project requires $1,675,000 in initial net working capital
Investment to get operational. Assume DEl ralses all equity for new projects externally
and that the NWC does not require floatation costs..
a. Calculate the project's initjal Time 0 cash flow, taking Into account all side effects. (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 riskler than a typical project for DEI, primarly
because the plant is belng located overseas. Management has told you to use an
adjustment factor of +3.0 percent to account for this Increased riskiness. Calculate the
appropriate discount rate to use when evaluating DEI's project. (Do not round
intermedlate calculations and enter your answer as a percent rounded to 2 decimal
places, e.g..3216.)
c. The manufacturing plant has an elght-year tax life, and DEI uses straight-lIne
depreclation to a zero salvage value. At the end of the project (that is, the end of Year
, the plant and equipment can be scrapped for $6.0 million. What is the aftertax
salvage value of this plant and equipment? (Do not round intermedlate 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 $8,300,000 in annual fixed costs. The plan is to manufacture
19,750 RDSs per year and sell them at $11,150 per machine; the variable production
costs are $9,900 per RDS. What is the annual operating cash flow (OCF) from this
project? (Do not round intermedlate 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 primarlly 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 intermedlate
calculations and round your answer to 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 chlef financlal officer; all he wants to know is
what the RDS project's Intemal rate of return (IRR) and net present value (NPV) are.
(Do not round intermediate calculations. Enter your NPV in dollars, not millions of
dollars, rounded to 2 decimal places, e.g.,1,234.567.89. Enter your IRR as a
percent rounded to 2 decimal places, e.g.,3216.)
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