Please answer the entire questions!!! Suppose you have been hired as a financial
ID: 2718656 • Letter: P
Question
Please answer the entire questions!!!
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 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 $7.78 million after taxes. In five years, the land will be worth $8.08 million after taxes. The company wants to build its new manufacturing plant on this land: the plant will cost $13.72 million to build. The following market data on DEI's securities are current: Debt: 46.800 7.1 percent coupon bonds outstanding. 19 years to maturity, selling for 93.2 percent of par: the bonds have a $1,000 par value each and make semiannual payments. Common stock: 768.000 shares outstanding, selling for $95.80 per share: the beta is 1.11. Preferred stock: 36.800 shares of 6.35 percent preferred stock outstanding, selling for $93.80 per share. Market: 7.15 percent expected market risk premium: 5.35 percent risk-free rate. DEI's tax rate is 38 percent. The project requires $915,000 in initial net working capital investment to get operational.Requirement 1: Calculate the project's Time 0 cash flow, taking into account all side effects. Assume that any NWC raised does not require floatation costs. (Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567).) Initial Time 0 cash flow Requirement 2: 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. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).) Discount rate % Requirement 3: The manufacturing plant has an eight-year tax life, and DEI uses straightline depreciation. At the end of the project (i.e.. the end of year 5), the plant can be scrapped for $1.68 million. What is the aftertax salvage value of this manufacturing plant? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567).) Aftertax salvage value Requirement 4: The company will incur $2,480,000 in annual fixed costs. The plan is to manufacture 14.800 RDSs per year and sell them at $12,200 per machine: the variable production costs are $11,400 per RDS. What is the annual operating cash flow. OCF. from this project? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567).) Operating cash flow Requirement 5: Calculate the net present value. (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) Net present value Calculate the internal rate of return. (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).) Internal rate of return %Explanation / Answer
Answers
Requirement 1
Initial Time 0 Cash Flows = $ - 22,415,000
Requirement 2
Discount rate = 10.04 %
Requirement 3
Aftertax salvage value = $ 1,041,600
Requirement 4
Operating Cash Flow = $ 6,454,900
Requirement 5
Net Present Value = $ 7,682,673.44
Requirement 6
Internal Rate of Return = 20.98%
Cost of Land three years again 7 Million Current Price 7.78 Million Cost of Plant and Machinery 13.72 Million Initial net working capital 915000 Project's time 0 cash flows Opportunity Cost of Land -7780000 Cost of Plant and machinery -13720000 Initial Net working capital -915000 Total time 0 cash flows -22415000 Calculation of appropriate discount rate Debt Coupon 7.10% semi-annual payments Time to maturity 19 years or 38 semi-annual periods Par Value 1000 Current Market Price 93.20% of par 932 Coupon payment = 1000 * 7.1% * 0.5 = 35.5 Let r be the required rate of return. Current price of bond can be calculated using the below formula 932 = 35.5 * [(1-(1/(1+r)^38))/r] + 1000/(1+r)^38 or 932 - 35.5 * [(1-(1/(1+r)^38))/r] - 1000/(1+r)^38 = 0 Let r = 4% or annual rate of 4% *2 = 8%, then LHS will be =932 - 35.5 * [(1-(1/(1+0.04)^38))/0.04] - 1000/(1+0.04)^38 = 932- 35.5 * [(1-(1/4.438813))/0.04] - 1000/4.438813 = 932 - 35.5 * [(1-0.225285)/0.04] - 1000 * 0.225285 = 932 - 35.5 * (0.774715/0.04) - 1000 * 0.225285 = 932 - 35.5*19.36786 - 1000 * 0.225285 = 932 - 687.5592 - 225.2854 = 19.15539 Let r = 3.75% or annual rate of 7.5%, then LHS will be =932 - 35.5 * [(1-(1/(1+0.0375)^38))/0.0375] - 1000/(1+0.0375)^38 = 932- 35.5 * [(1-(1/4.050867))/0.0375] - 1000/4.050867 = 932 - 35.5 * [(1-0.246861)/0.0375] - 1000 * 0.246861 = 932 - 35.5 * (0.753139/0.0375) - 1000 * 0.246861 = 932 - 35.5*20.08371 - 1000 * 0.246861 = 932 - 712.9718 - 246.8607 = -27.8326 r = 0.0375 + [(-27.8326 * (0.0375-0.04)]/(19.15539-(-27.8326)] r = 0.0375 + (0.0695815/46.98799) r = 0.0375 + 0.00148 r = 0.03898 cost of debt = 0.03898 * 2 *100 = 0.07796 or 7.7796% or 7.78% (rounded off) Cost of Preferred stock Current price =$ 93.80 Annual Dividend = 6.35% Annual Dividend amount = $ 100 * 6.35% = $ 6.35 Let r be the required rate of return Current Price = Dividend / required rate of return Required rate of return = Dividend / current price = 6.35/93.80 0.06769723 or 6.77% (rounded off) Cost of Equity risk-free rate 5.35% Market risk premium 7.15% Beta of stock 1.11 Expected return on stock = risk-free rate + beta * market risk premium = 5.35%+1.11*7.15% 13.29% (rounded off) Market Value of Debt Number of Bonds outstanding 46800 Current price is 93.2% par or 1000*93.2% = 932 Market Value of Debt = 46800 * 932 43617600 Market Value of Common stock Number of Shares outstanding 768000 Current Market Price 95.8 Market Value of Common stock = 768000*95.8 = 73574400 Market Value of Preferred stock Number of shares outstanding 36800 Current market Price 93.8 Market Value of preferred stock = 36800 * 93.8 = 3451840 Total Market value of company = market value of debt+market value of common stock+market value of preferred stock =43617600+73574400+3451840 120643840 Weight of Equity = market value of equity / total market value = 73574400/120643840 0.609848 or 0.6098 Weight of Preferred stock = market value of preferred stock/totalmarket value = 3451840/120643840 = 0.0286 Weight of debt = market value of debt / total market value = 43617600/120643840 = 0.3615402 or 0.3615 Tax Rate of the company 38% Weighted Average cost of capital WACC = weight of debt * cost of debt * (1- tax rate) + weight of preferred stock * cost of preferred stock +weight of equity * cost of equity WACC = 0.3615 *7.78% * (1-0.38) + 0.0286 * 6.77% + 0.6098 * 13.29% 0.1004036 or 10.04% Cost of Manufacturing Plant 13720000 Life of the machine 8 years Depreciation method straight line Depreciation amount = 13720000/8 = 1715000 Salvage value of the plant 1680000 After-tax salvage value of the plant 1041600 1680000 * (1-0.38) No of units manufactured 14800 sale price 12200 Variable costs 11400 Calculation of Annual Operating Cash Flow Sales = 14800 * 12200 = 180560000 Variable costs = 14800 * 11400 = 168720000 Annual Fixed Costs 2480000 Depreciation 1715000 EBIT 7645000 Tax at 38% 2905100 Net Income 4739900 Operating Cash flow (net income + depreciation) 6454900 Present value of Operating Cash Flows for 5 years at 10.04% = 6454900 * [(1-(1/(1.1004)^5))/0.1004] = 6454900 * [(1-(1/1.61344))/0.1004] = 6454900 * [(1-0.619794)/0.1004] = 6454900 * (0.380206/0.1004) = 6454900 * 3.786916 = 24444164 After-tax salvage value of Plant 1041600 After-tax sale value of land 8080000 Total Salvage Value 9121600 Present value of salvage value at 10.04% = 9121600/1.1004^5 5653509.4 Calculation of Net Present value Initial Investment -22415000.00 Present Value of Annual cash flows 24444164.09 Present value of salvage value 5653509.35 Net Present Value (sum of all flows) = 7682673.44 Total Cash flows associated with the project year 0 1 2 3 4 5 Initial investment -22415000.00 Annual Operating cash flow 6454900 6454900 6454900 6454900 6454900 Salvage value 9121600 Total Cash Flows -22415000.00 6454900 6454900 6454900 6454900 15576500 Internal rate of return (IRR) =irr(annual total cash flows) 20.98%