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Item 6

Item 6 2.27 points

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 $7.2 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 $7.74 million after taxes. In five years, the land will be worth $8.04 million after taxes. The company wants to build its new manufacturing plant on this land; the plant will cost $13.56 million to build. The following market data on DEI’s securities are current:

Debt:	92,800 7.2 percent coupon bonds outstanding, 26 years to maturity, selling for 93.6 percent of par; the bonds have a $1,000 par value each and make semiannual payments.
Common stock:	1,760,000 shares outstanding, selling for $95.40 per share; the beta is 1.15.
Preferred stock:	83,000 shares of 6.4 percent preferred stock outstanding, selling for $93.40 per share.
Market:	6.85 percent expected market risk premium; 5.2 percent risk-free rate.

DEI’s tax rate is 24 percent. The project requires $895,000 in initial net working capital investment to get operational.
a.	Calculate the project’s Time 0 cash flow, taking into account all side effects. Assume that any NWC raised does not require floatation costs. (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.)
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 +2 percent to account for this increased riskiness. Calculate the appropriate discount rate to use when evaluating DEI’s project. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
c.	The manufacturing plant has an eight-year tax life, and DEI uses straight-line depreciation. At the end of the project (i.e., the end of Year 5), the plant can be scrapped for $1.64 million. What is the aftertax salvage value of this manufacturing plant? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)
d.	The company will incur $2,440,000 in annual fixed costs. The plan is to manufacture 14,400 RDSs per year and sell them at $11,800 per machine; the variable production costs are $11,000 per RDS. What is the annual operating cash flow, OCF, from this project? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)
e.	Calculate the project's net present value. (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)
f.	Calculate the project's internal rate of return. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

1-	initial investment
	cost of machine		-13560000
	working capital		-895000
	total cash outflow		-14455000
2-	Discount rate
semiannual before tax cost of debt = Using rate function in MS excel	rate(nper,pmt,pv,fv,type) nper = 52 pmt = 36 pv = -936 fv =1000 type =0	RATE(52,36,-936,1000,0)	3.89%
annual after tax cost of debt	2*3.89*(1-.24)	5.9128	5.91
cost of preferred stock	preferred dividend/market price	6.4/93.4	6.85%
cost of common stock = risk free rate+(market risk premium)*beta	5.2+(6.85)*1.15		13.08
WACC
source	value	weight	component ost	weight*component cost
debt	86860800	0.330876857	5.91	1.95548223
preferred	7752200	0.029530278	6.85	0.2022824
common stock	167904000	0.639592864	13.08	8.36587467
total	262517000
WACC = sum of weight*component cost				10.5236393
Discount rate = WACC + additional premium	10.52+2			12.52
3-
Cost of machine		13560000
acumulated depreciation upto year 5 =(13560000/8)*5		8475000
book value of machine		5085000
sale value of machine		1640000
loss on sale of machine		3445000
tax credit on loss on sale of machine	3445000*24%	826800
after tax sale value with tax credit	1640000+826800	2466800
4-
Year	0	1	2	3	4	5
total cash outflow	-14455000
revenue= unit sold*selling price		169920000	169920000	169920000	169920000	169920000
variable production cost		158400000	158400000	158400000	158400000	158400000
fixed cost		2440000	2440000	2440000	2440000	2440000
annual depreciation =13560000/8		1695000	1695000	1695000	1695000	1695000
operating profit		7385000	7385000	7385000	7385000	7385000
less taxes -24%		1772400	1772400	1772400	1772400	1772400
after tax profit		5612600	5612600	5612600	5612600	5612600
add depreciation		1695000	1695000	1695000	1695000	1695000
recovery of working capital						825000
after tax sale value with tax credit						2466800
net operating cash flow	-14455000	7307600	7307600	7307600	7307600	10599400
5-
Year	0	1	2	3	4	5
net operating cash flow	-14455000	7307600	7307600	7307600	7307600	10599400
PVF at 12.52% =1/(1+r)^n	1	0.888730892	0.7898426	0.70195752	0.62385133	0.554436
present value of operating cash flow	-14455000	6494489.868	5771853.78	5129624.76	4558855.99	5876688.4
NPV =sum of present value of cash flow	13376512.80
IRR =Using IRR function in MS excel	IRR(H4631:M4631)	44.01%

X New Microsoft Office Excel Worksheet Microsoft Excel Cla Formulas Data Home Insert Page Layout Review View Cut Σ AutoSum A A Wrap Text Percentage Calibri 11 ECopy Fill Сopy BIU E E Merge & Center Conditional Format Formatting as Table Styles Paste +.0 .00 .00.0 Cell Insert Delete Format Sort & Find & % Clear Format Painter Filter Select Styles Editing Clipboard Font Alignment Number Cells fRATE(52,36,-936,1000,0) J4591 Q. Е F G K L M O P R S 4584 initial investment cost of machine working capital total cash outflow 1- 4585 4586 -13560000 4587 -895000 -14455000 4588 4589 Discount rate 2- semiannual before tax Cost of debt Using rate function in MS 4590 rate(nper,pmt,pv, fv, type nper 52 pmt 36 pv -RATE (52,36, 936 fv -1000 type -0 936,1000,0) 3.89% 4591 excel annual after tax cost of 2*3.89*(1-.24) 5.91 4592 5.9128 4593 cost of preferred stock preferred dividend/marke6.4/93.4 6.85% 4594 4595 Cost of common stock 5.2+(6.85) *1.15 13.08 4596 4597 4598 WACC value weight 86860800 0.330876857 component weight*component cost 5.91 1.95548223 4599 source debt 4600 preferred 7752200 0.029530278 167904000 0.639592864 6.85 0.2022824 4601 13.08 8.36587467 4602 common stock total 4603 262517000 WACC sum of weight*component cost Discount rate WACC 10.52+2 Sheet25 Sheet26 4604 10.5236393 4605 12.52 Sheet23 Sheet24 Sheet27 Sheet28 Sheet29 Sheet22 Ill

X New Microsoft Office Excel Worksheet Microsoft Excel Cin Formulas Data Home Insert Page Layout Review View Cut Σ AutoSum A A Wrap Text Percentage Calibri 11 ECopy Fill BIU EB E Merge & Center Conditional Format Formatting as Table Styles Paste +.0 .00 Cell Insert Delete Format Sort & Find & % .00.0 Clear Format Painter Filter Select Editing Clipboard Font Alignment Number Styles Cells fix =IRR(H4631:M4631) 4635 Q. E G Н K L M N O R S after tax sale value with tax credit 4627 2466800 7307600 10599400 net operating cash flow 7307600 4628 -14455000 7307600 7307600 5- 4629 4630 Year 0 1 2 3 4 5 net operating cash flow PVF at 12.52% =1/(1+r) ^r present value of operat NPV -sum of present va IRR Using IRR function in MS excel 7307600 10599400 10.888730892 0.7898426 0.70195752 0.62385133 0.554436 6494489.8685771853.785129624.764558855.995876688.4 4631 -14455000 7307600 7307600 7307600 4632 4633 -14455000 4634 13376512.80 IRR(H4631:M4631) 44.01% 4635 4636 4637 4638 4639 4640 4641 4642 4643 4644 4645 4646 4647 4648 4649 4650 Sheet23 Sheet24 Sheet25 Sheet26 Sheet27 Sheet28 Sheet29 Sheet22