Suppose you have been hired as a financial consultant to Defense Electronics, incorporated (OE), a farge, publicly traded firm that is the market share looder 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 $5.1 million in anticipation of using it as a toxic dimp site for waste chemicals, but it built a piping system to safely discard the chemicals instead. The land was appraised last week for $5.9 million on an aftertox basis. In five years, the aftertax value of the land will be $6.3 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 $32.48 million to buld. The following market data on DEl's securities is current: Debt Common stock: Preferred stock Morket: 118,0007.2 percent coupon bonds outstanding. 27 years to maturity, selling for 108 percent of par; the bonds have a par value of $2,000 and make semiannual payments. 9.400,000 shares outstanding, selling for $71.60 per share; the beta is 1.1. 456,000 shares of 4.8 percent preferred stock outstanding, selling for $81.60 per share; the stock has a par value of $100. 7 percent expected market risk premium; 3.7 percent risk-free rate. DEI uses G.M. Wharton as its lead underwriter. Wharton charges DEI spreads of 6.5 percent on new common stock issues, 5.5 percent on new preferred stock issues, and 4.5 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 buld the plant by issuing new shares of common stock. DE''s tax rate is 21 percent. The project requires $1,450,000 in initial net working capital investment to get operational. Assume Wharton raises all equity for new projects externally. a. Calcutate the project's initial Year 0 cash flow, taking into account all side effects. Assume that the net working capital will not require flotation costs. (A negative answer should be indicated by a minus sign. Do not round intermediate b. The new RDS project is somewhat riskier than a typical project for DEL, primarily because the plant is being located overseas. Management has told you to use an adjustment factor of 2 pereent to account for this increased fiskiness. Calculate the appropriate discount rate to use when evaluating DEI's project, (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) c. The manufacturing plant has an elght-year tax life, and DEI 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 $5.1million. What is the aftertax salvage value of this plant and equipment? (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.) d. The company will incur $7,400,000 in annual fixed costs. The plan is to manufacture 20,000 RDSs per year and sell them at $11,100 per machine; the variable production costs are $9,700 per RDS. What is the annual operating cash flow (OCF) from this project? (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.) e. DEl'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 break-even quantity of RDSs sold for this project? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.) f. Finally, DEl's president wants you to throw all your calculations, assumptions, and everything else into the report for the chief financial officer; all he wants to know is what the RDS project's internal rate of return (IRR) and net present value (NPV) are. (Do not round intermediate calculations. Enter your NPV answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g. 1,234,567.89. Enter your IRR answer as a percent rounded to 2 decimal places, e.g., 32.16.)
