Reference no: EM132961143

Suppose 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 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 $4.4 million on an after-tax basis. In five years, the after-tax value of the land will be $4.8 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 will cost $37 million to build.

The following market data on DEI's securities are current:

Debt: 210,000 6.4% coupon bonds outstanding, 25 years to maturity, selling for 108% of par; the bonds have a $1,000 par value each and make semiannual payments

Common stock: 8,300,000 shares outstanding, selling for $68 per share; the beta is 1.1

Preferred stock: 450,000 shares of 4.5% preferred stock outstanding, selling for $81 per share

Market: 7% expected market risk premium; 3.5% risk-free rate

• DEI uses G.M. Wharton as its lead underwriter. Wharton charges DEI spreads of 8% on new common stock issues, 6% on new preferred stock issues, and 4% 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 tax rate is 35%. The project requires $1,300,000 in initial net working capital investment to get operational. Assume Wharton raises all equity for new projects externally and that the NWC does not require flotation costs.

Problem a. Calculate the project's initial Time 0 cash flow, taking into account all side effects. (Negative amount should be indicated by a minus sign. Round the intermediate calculations to 4 decimal places. Round the final answer to the nearest whole dollar. Omit $ sign in your response.)

Problem 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 adjustment factor of 12% to account for this increased riskiness. Calculate the appropriate discount rate to use when evaluating DEI's project. (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places.)

Problem c. The manufacturing plant belongs to CCA Class 43 (30%). At the end of the project (that is, the end of Year 5), the plant can be scrapped for $5.1 million. What is the PVCCATS of this plant and equipment? (Do not round intermediate calculations. Round the final answer to the nearest whole dollar. Omit $ sign in your response.)

Problem d. The company will incur $6,700,000 in annual fixed costs. The plan is to manufacture 15,300 RDSs per year and sell them at $11,450 per machine; the variable production costs are $9,500 per RDS. What is the annual operating cash flow (OCF) from this project? (Enter the answer in dollars. Do not round intermediate calculations. Round the final answer to the nearest whole dollar. Omit $ sign in your response.)

Problem e. DEI's comptroller is primarily interested in the impact of DEI'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. Round the final answer to nearest whole number.)

Problem f. Finally, DEI'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. (Enter the NPV in dollars. Enter the IRR as a percent. Do not round intermediate calculations. Round the final answers to 2 decimal places. Omit $ sign in your response.)