In: Finance
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 fiveyear project. The company bought some land three years ago for $4.5 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 $5 million after taxes. In five years, the land will be worth $5.3 million after taxes. The company wants to build its new manufacturing plant on this land; the plant will cost $15 million to build. The following market data on DEI’s securities are current: 
Debt: 
40,000 6.2 percent coupon bonds outstanding, 25 years to maturity, selling for 95 percent of par; the bonds have a $1,000 par value each and make semiannual payments. 
Common stock:  825,000 shares outstanding, selling for $97 per share; the beta is 1.15. 
Preferred stock:  45,000 shares of 5.8 percent preferred stock outstanding, selling for $95 per share. 
Market:  7 percent expected market risk premium; 3.8 percent riskfree rate. 
DEI’s tax rate is 34 percent. The project requires $825,000 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 eightyear 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 $2.1 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 $3,500,000 in annual fixed costs. The plan is to manufacture 12,000 RDSs per year and sell them at $10,800 per machine; the variable production costs are $9,900 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:  
(a) 
Calculate the net present value. (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) 
Net present value  $ 
(b) 
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 % 
1 
cost of machine 
15000000 

investment in working capital 
825000 

initial cash outlay 
15825000 

2 
cost of debt 
using rate function in ms excel 
rate(nper,pmt,pv,fv,type) 
3.31% 

Annual after tax rate 
(3.31*2)*(1.34) 
4.3692 

cost of preferred stock 
preferred dividend/market price 
5.8/95 
6.11% 

cost of equity 
risk free rate+(market risk premium )*beta 
3.8+(7)*1.15 
11.85 

WACC on market value weights 

source 
value 
weight 
cost 
weight*cost 

debt 
38000000 
0.310711365 
4.37 
1.35780867 

preferred 
4275000 
0.034955029 
6.11 
0.21357522 

equity 
80025000 
0.654333606 
11.85 
7.75385323 

122300000 
WACC 
sum of weight*cost 
9.33 

WACC for project 
9.33+2 
11.33% 

3 
book value of machine after 5 years 
15000000*(1accumulated depreciation rate) 
15000000*(1.625) 
5625000 

scrap value of machine 
2100000 

loss on sale of machine 
56250002100000 
3525000 

tax benefit on loss on sale of machinesale of 
3525000*34% 
1198500 

after tax salvage value 
2100000+1198500 
3298500 

year 
0 
1 
2 
3 
4 
5 

initial investment 
15825000 

sales 
129600000 
129600000 
129600000 
129600000 
129600000 

less variable cost 
118800000 
118800000 
118800000 
118800000 
118800000 

less fixed cost 
3500000 
3500000 
3500000 
3500000 
3500000 

less depreciation 
1875000 
1875000 
1875000 
1875000 
1875000 

operating profit 
5425000 
5425000 
5425000 
5425000 
5425000 

after tax profit = operating profit*(1 34%) 
3580500 
3580500 
3580500 
3580500 
3580500 

net operatin after profit = after tax profit+ depreciation 
5455500 
5455500 
5455500 
5455500 
5455500 

recovery of working capital 
825000 

after tax scrap value 
3298500 

net operating cash flow 
15825000 
5455500 
5455500 
5455500 
5455500 
9579000 

present value of cash flow = net operating cash flow/(1+r)^n r= 11.33% 
15825000 
4900296.416 
4401595.631 
3953647.38 
3551286.61 
5600916.9 

NPV = sum of present value of cash flow 
6582742.9 

IRR = using irr function in MS excel =irr(15825000,5455500,5455500,5455500,54555500,9579000) 
25.56% 