Photochronograph Corporation (PC) manufactures time series photographic equipmen
ID: 2754170 • Letter: P
Question
Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt-equity ratio of .62. It’s considering building a new $71.7 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $7.92 million in perpetuity. There are three financing options:
A new issue of common stock: The required return on the company’s new equity is 15.1 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 .10. (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? (Do not round intermediate calculations. 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).)
a.A new issue of common stock: The required return on the company’s new equity is 15.1 percent.
Explanation / Answer
1 If Stock Issue Particulars Amt in $s Cash Outflow/Building Cost -71.7 Millions After tax Cash Inflow 7.92 Millions Cost of Equity 15.1 Present Value of Cash Inflow (7.92/15.1%) 52.45 NPV -19.25 (Not suggested as NPV negative) 2 Issue of 20 years Bonds After tax Cash Inflow 7.92 Millions Cost of Debt 7.20 Present Value of Cash Inflow (7.92/7.2%) 110.00 Interest on Debt every year(71.7*7.2%) 5.16 Post tax Interest on Debt every year(5.1624*70%) 3.61 Cumulative Value of annuity factor for 20 years@7.2% 10.43 Present value of Interest paid during 20 years 37.70 Annuity factor at 20th year 0.25 Present value of Cash outflow of redemption proceeds(71.7*0.2489) 17.85 Total Present value of Cash Outflow (37.69+17.84) 55.54 NPV (110-55.54) 54.46 As NPV positive we can accept) 3 Usage of Accounts payable Calculation OF WACC Source Ratio Cost WACC Debt 0.62 5.04 3.1248 Equity 0.38 15.1 5.738 WACC 8.8628 After tax Cash Inflow 7.92 Millions Cost of Debt 8.86 Present Value of Cash Inflow (7.92/8.86%) 89.36 Investment top be repaid in 10 installments 7.17 per year (i.e., Given target ratio is 0.1 to long term debt) Cumulative Value of annuity factor for 10 years@8.86% 10.43 Present value of redemption of Debt (7.17*10.43) 74.79 NPV 14.57 Decision:- Out of the three alternatives alternative 2 is the best source