Question
Suppose you have been hired as a financial consultant to Defense Electronics, Inc. (DEI), a large, publicly traded firm that is the market share leader
Suppose you have been hired as a financial consultant to Defense Electronics, Inc. (DEI), 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 $7 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. If the land were sold today, the net proceeds would be $7.75 million after taxes. In five years, the land will be worth $8.05 million after taxes. The company wants to build its new manufacturing plant on this land; the plant will cost $13.6 million to build. The following market data on DEIs securities are current: |
Debt: | 46,500 6.8 percent coupon bonds outstanding, 20 years to maturity, selling for 93.5 percent of par; the bonds have a $1,000 par value each and make semiannual payments. |
Common stock: | 765,000 shares outstanding, selling for $95.50 per share; the beta is 1.14. |
Preferred stock: | 36,500 shares of 6.2 percent preferred stock outstanding, selling for $93.50 per share. |
Market: | 7 percent expected market risk premium; 5.2 percent risk-free rate. |
DEIs tax rate is 35 percent. The project requires $900,000 in initial net working capital investment to get operational. |
Requirement 1: | |
Calculate the projects Time 0 cash flow, taking into account all side effects. Assume that any NWC raised does not require floatation costs. (Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567).) |
Initial Time 0 cash flow | $ |
Requirement 2: | |
The new RDS 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 +2 percent to account for this increased riskiness. Calculate the appropriate discount rate to use when evaluating DEIs project. (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).) |
Discount rate | % |
Requirement 3: | |
The manufacturing plant has an eight-year tax life, and DEI uses straightline depreciation. At the end of the project (i.e., the end of year 5), the plant can be scrapped for $1.65 million. What is the aftertax salvage value of this manufacturing plant? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567).) |
Aftertax salvage value | $ |
Requirement 4: | |
The company will incur $2,450,000 in annual fixed costs. The plan is to manufacture 14,500 RDSs per year and sell them at $11,900 per machine; the variable production costs are $11,100 per RDS. What is the annual operating cash flow, OCF, from this project? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567).) |
Operating cash flow | $ |
Requirement 5: | |
(a) | Calculate the net present value. (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) |
Net present value | $ |
(b) | Calculate the internal rate of return. (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).) |
Internal rate of return | % |
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