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You have been hired as a financial consultant to Defence Electronics Inc. ( DEI ) , a large, publicly traded firm that is the market
You have been hired as a financial consultant to Defence 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 year project. The company bought some land years ago for $ 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 $ million. In years, the land value
will be $ million, but the company expects to keep it for a future project. The company wants
to build its new manufacturing plant on this land; the plant will cost $ million to build and
have $ million salvage value at the end of years. It will belong to CCA Class @
The following market data on DEI's securities are current:
Debt: coupon bonds outstanding, years to maturity, selling for of par;
the bonds have a $ par value each and make semiannual payments.
Common stock: shares outstanding, selling for $ per share with beta.
Preferred stock: shares of yield are outstanding, selling for $ per share.
Market: expected market risk premium; riskfree rate.
DEI uses GM Wharton as its lead underwriter. Wharton charges DEI spreads of on new
common stock issues, on new preferred stock issues and 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. DEI's taxrate is The project requires $ in initial net
working capital investment to get operational, which will be recovered at the end.
Required:
a Calculate the companys WACC based on both internal and external financing.
b Estimate the companys EBIT, FCF Net Income and EPS.
c 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
to account for this increased riskiness. Calculate the appropriate discount rate to use
when evaluating DEI's project and outline the factors increasing the riskiness.
d Assuming that the appropriate discount rate is calculate the NPV of the opportunity if
the company will incur $ in annual fixed costs, manufacturing RDSs per
year with the variable production costs of $ per RDS and sell them at $ per
machine. Based on NPV make a supported recommendation regarding the opportunity.
e Based on d calculate the minimum number of RDSs which must be sold annually in order
for DEI to breakeven on the opportunity.
f If Both the Bonds and Preferred Stock can be called with premium, then should the
company call either or both of them?
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