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 $7.1 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: 90,800 7.2 percent coupon bonds outstanding, 26 years to maturity. selling for 94.6 percent of par; the bonds have a $1,000 par value each and make semiannual payments. 1,560,000 shares outstanding, selling for $94.40 per share; the beta is Common stock: 1.24. Preferred stock: 73,000 shares of 6.4 percent preferred stock outstanding, selling for $92.40 per share. Market: 7.2 percent expected market risk premium; 5.05 percent risk-free rate. DEI's tax rate is 24 percent. The project requires $845,000 in initial net working capital investment to get operational.

Answer 1

E16 -: * fic =D16/$D$25 B 15 DE F WACC (Cost Market value Weights %*Weights) $ 147,264,000 0.6138] 2.38% =1560000*94.4 After tax cost % 3.88% =-5.05%+1.24*7.2% Common stock Preferred stock $ 0.0281 0.19% 6.93% =6.4/92.4 6,745,200 =73000*92.4 Debt $ 0.3580 2.09% 5.84% =RATE(26*2,72/2,-946,1000)*2*(1-24%) 85,896,800 =90800*946 Total $ 239,906,000 1.00 WACC Add: Risk Premium for project Relavant WACC 4.67% 1.00% 5.67% Present resale value of land $ Increase in working capital $ Construction cost of plant $ (7,640,000) (845,000) (13,160,000) 34 Cash flows in year o (21,645,000) 35 36 37 c) 38 13160000x5/8 39 Asset cost Less: Depreciatioon charged 1 WDV of machine at the time of sale 2 Sale value of machine 2-1. Profit/(Loss) on sale 4 Less: Tax @ 24% 2-4. After tax cash flows from sale of asset 13,160,000 8,225,000 4,935,000 1,540,000 (3,395,000) (814,800) 2,354,800 $

C65 - X V fx =IRR(C58:C63) C D $ 144,720,000 =13400x10800 A 46 d) Sales 47 Less: Costs Dereciation $ 136,340,000 =13400x10000+2340000 $ 1,645,000 =13160000/8 EBIT $ Less: Tax @ 24% $ Net income $ Add: Depreciation $ Operating cash flows (OCF) $ 6,735,000 1,616,400 5,118,600 1,645,000 6,763,600 Year .. ob sl Cash flows 0 $ -21,645,000 1 $ 6,763,600 2 $ 6,763,600 3 $ 6,763,600 4 $ 6,763,600 5 $ 17,903,400 PVIF @ 5.67% 1.000 $ 0.946 $ 0.896 $ 0.848 $ 0.802 $ 0.759 $ Present value (21,645,000.00) 6,400,933.98 6,057,714.20 5,732,897.96 5,425,498.45 13,591,352.48 64 65 IRR 25.38% $ 15,563,397.08 67 Net present value 68 69 a) $ -21,645,000 70 b) 5.67% 71 c) $ 2,354,800 72 d) $ 6,763,600 73 e) $ 15,563,397.08 74 25.38%

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