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 (RDS). 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 $7.2 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 $7.65 million after taxes. In five years, the land will be worth $7.95 million after taxes. The company wants to build its new manufacturing plant on this land; the plant will cost $13.2 million to build. The following market data on DEI's securities are current: Debt: 91,000 6.8 percent coupon bonds outstanding, 27 years to maturity, selling for 94.5 percent of par; the bonds have a $1,000 par value each and make semiannual payments. Common stock: 1,580,000 shares outstanding, selling for $94.50 per share; the beta is 1.25. Preferred stock: 74,000 shares of 6.2 percent preferred stock outstanding, selling for $92.50 per share. Market: 6.8 percent expected market risk premium: 5.1 percent risk-free rate.

Answer 1

E16 ✓ fc =D16/$D$25 X AB D F WACC (Cost Weights %*Weights) 0.61661 8.39% 15 Common stock After tax cost % 13.60% =5.1%+1.25*6.8% Market value $ 149,310,000 =1580000*94.5 Preferred stock $ 0.0283 0.19% 6.70% =6.2/92.5 6,845,000 =74000*92.5 Debt $ 0.3551 1.94% 5.45% =RATE(27*2,68/2,-945,1000)*2*(1-25%) 85,995,000 =91000*945 Total $ 242,150,000 1.00 WACC Add: Risk Premium for project Relavant WACC 10.51% 2.00% 12.51% 31 32 Present resale value of land Increase in working capital Construction cost of plants $ $ (7,650,000) (850,000) (13,200,000) 33 Cash flows in year 0 (21,700,000) 34 35 36 37 ) 38 13200000x5/8 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 @ 25% 2-4. After tax salvage value 13,200,000 8,250,000 4,950,000 1,550,000 (3,400,000) (850,000) 2,400,000 $

fic =IRR(C58:C63) с $ 147,150,000 =13500x10900 C65 X ✓ AB 46 d) Sales 47 Less: 48 Costs 49 Dereciation 50 51 EBIT 52 Less: Tax @ 25% Net income Add: Depreciation Operating cash flows (OCF) $ 138,700,000 $ 1,650,000 =13500x10100+2350000 =13200000/8 $ $ $ $ $ 6,800,000 1,700,000 5,100,000 1,650,000 6,750,000 Year Cash flows 0 $ -21,700,000 1 $ 6,750,000 2 $ 6,750,000 3 $ 6,750,000 4 $ 6,750,000 5 $ 17,950,000 PVIF @ 12.51% Present value 1.000 $ (21,700,000.00) 0.889 $ 5,999,412.69 0.790 $ 5,332,289.28 0.702 $ 4,739,348.74 0.624 $ 4,212,342.07 0.555 $ 9,956,100.59 IRR 25.24% Net present value $ 8,539,493.37 69 a) $ 70 b) 71 c) $ 72 d) $ 73 e) $ 74 f) -21,700,000 12.51% 2,400,000 6,750,000 8,539,493.37 25.24%

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