Suppose you have been hired as a financial consultant to Defense Electronics, Incorporated (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 $3.9 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. The land was appraised last week for $4.1 million on an aftertax basis. In five years, the aftertax value of the land will be $4.4 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 $37 million to build. The following market data on DEl's securities are current: DEI uses G.M. Wharton as its lead underwriter. Wharton charges DEl spreads of 7 percent on new common stock issues, 5 percent on new preferred stock issues, and 3 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 raise the funds needed to build the plant by issuing new shares of common stock. DEl's tax rate is 25 percent. The project requires $1.5 million in initial net working capital investment to get operational. Assume DEI raises all equity for new projects externally and that the NWC does not requires flotation costs. a. Calculate the project's initial 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, rounded to the nearest whole number, e.g., 1,234,567.) 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 percent to account for this increased riskiness. Calculate the appropriate discount rate to use when evaluating DEl'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 eight-year tax life, and DEl uses straight-line depreciation to a zero salvage value. At the end of the project (that is, the end of Year 5), the plant and equipment can be scrapped for $4.9 million. What is the aftertax salvage value of this plant and equipment? (Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to the nearest whole number, e.g., 1,234,567.) d. The company will incur $6.9 million in annual fixed costs. The plan is to manufacture 8,500 RDSs per year and sell them at $13,450 per machine; the variable production costs are $10,600 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, rounded to the nearest whole number, e.g., 1,234,567.) e. DEl's comptroller is primarily interested in the impact of DEl'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 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 IRR as a percent rounded to 2 decimal places, e.g., 32.16. Enter your NPV in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.)
