Question

Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt-equity ratio of .6. It’s considering building a new $63 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $7.9 million in perpetuity. The company raises all equity from outside financing. There are three financing options:

Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt-equity ratio of .6. It's considering building a new $63 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $7.9 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 71 percent of the amount raised. The required return on the company's new equity is 15 percent 2. A new issue of 20-year bonds: The flotation costs of the new bonds would be 2.6 percent of the proceeds. If the company issues these new bonds at an annual coupon rate of 6 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 .20. (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 intermediate calculations and enter your answer in dollars, not millions, rounded to the nearest whole dollar amount, e.g., 1,234,567.) NPV

Answer 1

A E Pre-tax cost of debt 6.00% I C D Flotation cost (r) Weights Weighted cost 2.60% 0.8333 2.17% 0.00% 0.1667 0.00% Long-term debt Accounts payable After-tax cost of debt 4 .74% 2 3 4 5 6 7 8 Total debt 1.0000 Required return on new equity 15.0% Flotation cost of debt u= 2.17% Flotation cost (r) 2.17% 7.10% Weights Weighted cost 0.3750 0.81% 0.6250 4.44% 10 Debt 11 Equity 12 13 14 Total debt 1.0000 15 Weighted flotation cost 5.25% 66,490,765 16 17 Initial cost 18 19 WACC 11.58% 20 21 NPV $ 1,730,306

A Flotation cost (r) Pre-tax cost of debt 0.06 2 Long-term debt 0.026 3 Accounts payable o Weights =1/1.2 1=0.2/1.2 Weighted cost =C2*B2 =C3*B3 After-tax cost of debt -61*(1-21%) 5 Total debt =SUM(C2:04) Required return on new equity 0.15 Flotation cost of debt u = =SUM(D2:03) 8 Flotation cost (r) =D7 0.071 Weights =0.6/1.6 =1/1.6 Weighted cost =C10*B10 =C11*B11 9 10 Debt 11 Equity 12 13 14 Total debt =SUM(C10:C12) 15 Weighted flotation cost u = =SUM(D10:011) =63000000/(1-D15) 16 17 Initial cost 18 19 WACC 20 =(C11*G5+C10*C2*G3)/(1-C10*C3) 21 NPV =7900000/B19-B17

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