Photochronograph Corporation (PC) manufactures time series photographic equipmen
ID: 2802938 • Letter: P
Question
Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debtequity ratio of .85. It’s considering building a new $40 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $5.2 million in perpetuity. The company raises all equity from outside financing. There are three financing options:
A new issue of common stock: The flotation costs of the new common stock would be 7 percent of the amount raised. The required return on the company’s new equity is 13 percent.
A new issue of 20-year bonds: The flotation costs of the new bonds would be 4.0 percent of the proceeds. If the company issues these new bonds at an annual coupon rate of 7 percent, they will sell at par.
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 40 percent tax rate.
Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debtequity ratio of .85. It’s considering building a new $40 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $5.2 million in perpetuity. The company raises all equity from outside financing. There are three financing options:
Explanation / Answer
Initial Outflow -4,00,00,000 Annual Cash flow to perpetuity 52,00,000 NPV=-40000000+5200000/Rwacc Weight Debt Equity Ratio 0.85 .85/1.85 0.459459 Equity 1.00 1/1.85 0.540541 Total Debt & Equity 1.85 In debt Payables are 20% Ratio Debt Wt Wt Paybales 0.20 .2/1.2 0.166667 0.459459 0.076577 Long Term Debt 1.00 1/1.2 0.833333 0.459459 0.382883 Total Debt & Equity 1.20 Calculation of Rwacc Cost of Equity 20% 13%+7% WE 0.459459 Cost of Debt 11% 7%+4% Wd 0.382883 Cost of payables Rwacc Wp 0.076577 Rwacc=20%*.459459+11%*.382883*(1-.4)+Rwacc*.076577 .923423*Rwacc=.1117162 Rwacc 0.12688 or 12.69% NPV=-40000000+5200000/12.69% 9,77,147