This is a comprehensive project evaluation problem that brings together much of what you have learned in this and previous chapters. Suppose he has been hired as a financial consultant to Defense Electronics, Inc. (DEI), a large, publicly traded company that is a market share leader in radar detection systems (RDS). The company is considering setting up a manufacturing facility abroad to produce a new line of RDS. This will be a five year project. The company bought land three years ago for $6 million in anticipation of using it as a toxic dumpsite for chemical waste, but instead built a pipeline system to safely dispose of the chemicals. The land was appraised last week at $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 DEI securities is up to date:

Debt: 10,000 8% coupon bonds outstanding, 15 years to maturity, selling at 94% of par; the bonds have a par value of $1,000 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

The DEI tax rate is 34%. The project requires $750,000 in initial net working capital investment to become operational.

Calculate the Time 0 cash flow of the project, taking into account all side effects.

The new RDS project is somewhat riskier than a typical DEI project, mainly because the plant will be located abroad. Management has told you to use an adjusted factor of +2% to account for this increased risk. Calculate the appropriate discount rate to use when evaluating the DEI project.

The manufacturing plant has a tax life of eight years and DEI uses straight-line depreciation. At the end of the project (ie, at the end of year 5), the plant can be scrapped for $2 million. What is the after-tax salvage value of this manufacturing plant?

The firm will incur $900,000 in annual fixed costs. The plan is to make 10,000 RDS per year and sell them for $10,000 per machine; variable production costs are $9,100 per RDS. What is the annual operating cash flow, OCF, for this project?

Finally, the DEI president wants you to put all your calculations, all your assumptions, and everything else in a report to the CFO; all he wants to know is the internal rate of return, the IRR, and the net present value, the NPV of the RDS project. What are you going to report?