Photochronograph Corporation (PC) manufactures time series photographic equipmen
ID: 2796960 • Letter: P
Question
Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt–equity ratio of .67. It’s considering building a new $65.7 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $7.82 million in perpetuity. There are three financing options: A new issue of common stock: The required return on the company’s new equity is 15.3 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 .14. (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?
Explanation / Answer
Debt/Equity= 0.67
1 + Debt/Equity = 1 + 0.67 (adding 1 both the side)
(Debt+Equity)/Equity = 1.67 (debt +equity = 1 since no preferred stock)
1/Equity = 1.67
Equity = 0.6
Debt = 0.4
WACC = 0.4*cost of debt*(1-tax rate) + 0.6*cost of common equity
WACC = 0.4*0.072*(1-0.3) + 0.6*0.153 = 0.02+0.1 = 0.3 = 3%
Using WACC we shall discount the cashflow to determine NPV
PV of Positive Cashflow using Annunity formula
PV = A/r
PV = 7.82/0.03 = $261 million
NPV = - $65.7 + $261 = $195.3
The NPV of the plant is $195.3