Question

Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt-equity ratio of .75. It’s considering building a new $66 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $7.8 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 7.4 percent of the amount raised. The required return on the company’s new equity is 13 percent.
2.	A new issue of 20-year bonds: The flotation costs of the new bonds would be 2.9 percent of the proceeds. If the company issues these new bonds at an annual coupon rate of 7 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 24 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.)

Answer 1

PC
Debt Equity Ratio =	0.75
New building plan worth =	$66 million
Expected After-Tax CF =	$7.8 million
Option I		Option II		Option III
New issue of Common Stock		New issue of 20-year old bonds		No Flotation Costs
Common Stock Capital (in $)	66,000,000	Bonds Issued (in $ mlns)	66,000,000	Accounts Payable (in $)	66,000,000
RRR =	13.00%	Annual Coupon Rate	7.00%	Target Accounts Payable to LT Debt	20.00%
RRR (in $ mlns)	8,580,000	RRR (in $ mlns)	4,620,000	Tax Rate	24.00%
Flotation Cost =	7.40%	Flotation Cost =	2.90%	Accounts Payable @ 24% (in $)	15,840,000
Flotation Cost (in $)	4,884,000	Flotation Cost (in $)	1,914,000
Considering the After Tax Expected Cash Flow of $7,800,000, Option II is best suited as it requires lesser cost of capital from all options.