This is a comprehensive project evaluation problem bringing together much of what you have learned in this and previous chapters. 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 $6 million in anticipation of using it as a toxic dumps site for waste chemicals, but it built a piping system to safely discard the chemicals instead. The land was appraised last week for $4.25 million. The company wants to build its new manufacturing plant on this land; the plant will cost $7.2 million to build.

The following market data on DEIs securities are current: Debt: 10,000 8% coupon bonds outstanding, 15 years to maturity selling for 94% of par; the bonds have a $1,000 par value each and make semiannual payments. Common Stock: 250,000 shares outstanding, selling for $65 per share; the beta is 1.3. Preferred stock: 10,000 shares of 7% preferred stock outstanding, selling for $81 per share. Market: 8% expected market risk premium; 5.65% risk-free rate DEIs tax rate is 34%. The project requires $750,000 in initial net working capital investment to get operational.

B. 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 adjusted factor of +2% to account for this increased riskiness. Calculate the appropriate discount rate to use when evaluating DEIs project.