Question

Photochronograph Corporation (PC) manufactures time series photographic equipment It is currently at its target debt-equity ratio of .65. It's considering building a new $58 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $4.9 million in perpetuity. The company raises all equity from outside financing. There are three financing options: 1. A new issue of common stock: The flotation costs of the new common stock would be 6.5 percent of the amount raised. The required return on the company's new equity is 10 percent. 2.A new issue of 20-year bonds: The flotation costs of the new bonds would be 2.1 percent of the proceeds. If the company issues these new bonds at an annual coupon rate of 4 percent, they will sell at par. 3. Increased use of accounts payable financing: Because this financing is part of the company's ongoing daily business, it has no flotation costs, and 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 10. (Assume there is no difference between the pretax and aftertax accounts payable cost) What is the NPV of the new plant? Assume that PC has a 21 percent tax rate. (Do not round jntermediate calculations and enter your answer in dollars, not millions, rounded to the nearest whole dollar amount, e.g., 1,234,567.) NPV

Answer 1

		Debt to Equity Ratio	0.65
		Debt=0.65 Equity
		Total Capital =1.65 Equity
		Debt to Total Capital	0.393939394	(0.65/1.65)
		Equity to total Capital	0.606060606	(1/1.65)
	X	Total Capital	$58,000,000
		Debt=0.3939*58 million	$22,848,485
	A	Equity =0.6060*58 million	$35,151,515
	B	Accounts Payable =0.1*Debt	$2,284,848
	C	20 year Bond issue	$20,563,636	(22848485-2284848)
	We=A/X	Weight of Equity	0.61
	Wa=B/X	Weight of Accounts Payable	0.04
	Wb=C/X	Weight of Bond	0.35
	Ce	Cost of Equity =10/(1-flotation Cost)	10.70%	(10/(1-0.065)
	Ca	Cost of Account Payable =WACC=Y
		Before tax cost of Bond =4/(1-flotation cost)	4.09%	(4/(1-0.021)
	Cb	After tax cost of Bond=4.09*(1-Tax Rate)	3.23%	(4.09*(1-0.21)
		Assume Weighted Average Cost of Capital =WACC=Y
		We*Ce+Wa*Y+Wb*Cb=WACC=Y
		WE*Ce+Wb*Cb=Y-Wa*Y=Y(1-Wa)
		0.61*10.7+0.35*3.23=Y*(1-0.04)
		WACC=Y=	7.94%
		Cash Flow per year in perpetuity	$4,900,000
	PV	Present Value of Cash inflows=4.9 million/Y	$61,720,004
	I	Present Value of Investment	$58,000,000
	NPV=PV-I	Net Present Value of the new plant	$3,720,004
		NPV	$3,720,004