Question

Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt-equity ratio of .66. It's considering building a new $65.6 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $7.45 million in perpetuity. There are three financing options: a. A new issue of common stock: The required return on the company's new equity is 15.2 percent. b. A new issue of 20-year bonds: If the company issues these new bonds at an annual coupon rate of 7.1 percent, they will sell at par. c. Increased use of accounts payable financing: Because this financing is part of the company's ongoing daily business, the company assigns it a cost that is the same as the overall firm WACC. Management has a target ratio of accounts payable to long- term debt of .12. (Assume there is no difference between the pretax and aftertax accounts payable cost.) If the tax rate is 21 percent, what is the NPV of the new plant? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.) Net present value

Answer 1

Step 1: calculation of WACC D/E= D/V=0.66/(1+0.66) E/V=1/(1+0.66) 0.66 0.397590361 0.602409639 B2/B1 B1/V=(B1/(B1+B2))*D/V (1/(1+0.12)) *0.397590361 0.12 0.354991394 0.042598967 B2/V=(B2/(B1+B2))*D/V (0.12/(1+0.12))*0.397590361 WACC=rs* (E/V)+rB1 *(B1/V)*(1-T)+r B2 *(B2/V) let the WACC be 'a' a=0.152*0.602409639+0.071*0.354991394*(1-0.21)+a*0.042598967 a=0.0915662651+0.0199114673 +0.042598967a a-0.042598967a=0.1114777324 0.957401033a=0.1114777324 a=0.1114777324/0.957401033 11.643786519% Step 2: calculation of NPV PV of cash in flow=7450000/11.643786518% Less : Initial cash outflow NPV 63982622.74 -65600000.00 -1617377.26

D/E Debt to equity ratio D/V Debt to value ratio E/V Equity to value ratio B2/B1 | Accounts payable to long term debt ratio B1/v Long term bond to value ratio B2/v Short term debt to value ratio WACC Weighted average cost of capital rs cost of equity rB1 cost of long term debt r B1 cost of short term debt T Tax rate Rounded figures are shown for display purpose only but entire figure is used for actual calculation.