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 $7.81 million in perpetuity. There are three
financing options:
If the tax rate is 34 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, e.g., 1,234,567. Round your
answer to 2 decimal places, e.g., 32.16.)
Net present value
$
Answer:
Target debt equity ratio = 0.66
Total liabilities / Equity = 0.66
Hence:
Total liabilities = 0.66 / (1 + 0.66) = 0.66/1.66
Equity = 1 / (1 + 0.66) = 1/1.66
Given that:
Management has a target ratio of accounts payable to long-term debt of .15.
Hence:
Accounts payable = 0.15 / Long-term debt
Weight of long accounts payable = (0.15 / (1 + 0.15)) * 0.66/1.66 = (0.15/1.15) * (0.66/1.66)
Weight of long-term debt = (1 / (1 + 0.15) * 0.66/1.66 = (1/1.15) * (0.66/1.66)
Cost of equity = 15.2%
New bonds are issued at par.
Cost of debt = 7.1%
Given that:
Company assigns accounts payable a cost that is the same as the overall firm WACC.
WACC = 15.2% * (1/1.66) + 7.1% * (1 - 34%) * (1/1.15) * (0.66/1.66) + WACC * (0.15/1.15) * (0.66/1.66)
=> WACC - WACC * (0.15/1.15) * (0.66/1.66) = 15.2% * (1/1.66) + 7.1% * (1 - 34%) * (1/1.15) * (0.66/1.66)
=> WACC * (1 - (0.15/1.15) * (0.66/1.66)) = 10.7767207962284%
=> WACC = 10.7767207962284%/ 94.8140387637507% = 11.3661657458564%
WACC = 11.3661657458564%
NPV = (Perpetual annual after-tax cash flows / WACC) - Initial investment
= 7810000 / 11.3661657458564% - 65600000
= $3112705.54
Net Present Value = $3,112,705.54
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