Reference no: EM132172625

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 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$7.64 million after taxes. In five years, the land will be worth $7.94 million after taxes. The company wants to build its new manufacturing plant on this land; the plant will cost $13.16 million to build. The following market data on DEI's securities are current:

Debt: 45,400 7.2 percent coupon bonds outstanding, 18 years to maturity, selling for 94.6 percent of par; the bonds have a $1,000 par value each and make semiannual payments.

Common stock: 754,000 shares outstanding, selling for $94.40 per share; the beta is 1.24.

Preferred stock: 35,400 shares of 6.4 percent preferred stock outstanding, selling for $92.40 per share.

Market: 7.2 percent expected market risk premium; 5.4 percent risk-free rate.

DEI's tax rate is 40 percent. The project requires $845,000 in initial net working capital investment to get operational.

Time 0 cash flow $ -21,645,000

Discount rate: 13.58%

After tax salvage value: $339,000

Operating cash flow: 5,686,000

A. The manufacturing plant has an eight-year tax life, and DEI uses straight-line depreciation. At the end of the project (i.e., the end of Year 5), the plant can be scrapped for $1.54 million. What is the after tax salvage value of this manufacturing plant?

B. Calculate the project's net present value.

C. Calculate the project's internal rate of return.