Photochronograph Corporation (PC) manufactures time series photographic equipmen
ID: 2655815 • Letter: P
Question
Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt–equity ratio of .57. It’s considering building a new $71.2 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $7.87 million in perpetuity. There are three financing options:
A new issue of common stock: The required return on the company’s new equity is 15 percent.
A new issue of 20-year bonds: If the company issues these new bonds at an annual coupon rate of 7.2 percent, they will sell at par.
Increased use of accounts payable financing: Because this financing is part of the company’s ongoing daily business, 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 .15. (Assume there is no difference between the pretax and aftertax accounts payable cost.)
If the tax rate is 30 percent, what is the NPV of the new plant? (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. Round your answer to 2 decimal places, e.g., 32.16.)
Net present value $
Explanation / Answer
Target Debt Equity Ratio = 0.57
Debt to Total Value Ratio = 0.57/1.57 = 57/157
Accounts Payable to long term debt ratio = 0.15/1
Account payable to total debt ratio = 0.15/1.15
Long term debt equity ratio = ( 1 - 0.15/1.15) * 57/157
Account Payabvle to Total Value ratio = 0.15/1.15 * 57/157
Equity to Total Value Ratio = 1/1.57 = 100/157
Cost of Equity = 15%
Cost of Account Payable = WACC
WACC = Cost of Debt * ( 1-Tax rate) * long term Debt/Total Value + Cost of Equity * Equity/Total Value = 7.2% * ( 1- 30%) * ( 1 - 0.15/1.15) * 57/157 + 15% * 100/157 = 0.1114528 or 11.14528%
Discount rate = WACC + WACC * Account payable to total debt ratio
= 11.14528% + 11.14528%* 0.15/1.15 * 57/157 = 11.67307%
NPV = After Tax Cash flow/Discount rate - Initial Investment = 7.87/11.67307% - 71.2 = -3779840.08
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