Question

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 $7.3 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 $7.77 million after taxes. In five years, the land will be worth $8.07 million after taxes. The company wants to build its new manufacturing plant on this land; the plant will cost $13.68 million to build. The following market data on DEI’s securities are current:

Debt:	93,400 7 percent coupon bonds outstanding, 24 years to maturity, selling for 93.3 percent of par; the bonds have a $1,000 par value each and make semiannual payments.
Common stock:	1,820,000 shares outstanding, selling for $95.70 per share; the beta is 1.12.
Preferred stock:	86,000 shares of 6.3 percent preferred stock outstanding, selling for $93.70 per share.
Market:	7.05 percent expected market risk premium; 4.95 percent risk-free rate.

DEI’s tax rate is 22 percent. The project requires $910,000 in initial net working capital investment to get operational.

Here are the associated question parts:

DEI’s tax rate is 22 percent. The project requires $910,000 in initial net working capital investment to get operational.
a.	Calculate the project’s Time 0 cash flow, taking into account all side effects. Assume that any NWC raised does not require floatation costs. ANSWER: -22,360,000
b.	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. ANSWER: 12.51 %

Please answer:

c.	The manufacturing plant has an eight-year tax life, and DEI uses straight-line depreciation. At the end of the project (i.e., the end of Year 5), the plant can be scrapped for $1.67 million. What is the aftertax salvage value of this manufacturing plant? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)
d.	The company will incur $2,470,000 in annual fixed costs. The plan is to manufacture 14,700 RDSs per year and sell them at $12,100 per machine; the variable production costs are $11,300 per RDS. What is the annual operating cash flow, OCF, from this project? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)
e.	Calculate the project's net present value. (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89)
f.	Calculate the project's internal rate of return. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

C-
What is the aftertax salvage value of this manufacturing plant
cost of plant		13680000
life of plant		8
Annual depreciation	13680000/8	1710000
Accumulated depreciation in last 5 years	1710000*5	8550000
Book value of equipment at the end of Year 5	13680000-8550000	5130000
loss on sale of plant	1670000-5130000	-3460000
tax credit on loss of disposal of plant	3460000*22%	761200
after tax sale proceeds with tax credit on loss of disposal of plant	1670000+761200	2431200
D-
What is the annual operating cash flow, OCF, from this project
Year	1	2	3	4	5
annual sales	177870000	177870000	177870000	1.78E+08	1.78E+08
variable production cost	166110000	166110000	166110000	1.66E+08	1.66E+08
annual fixed cost	2470000	2470000	2470000	2470000	2470000
depreciation	1710000	1710000	1710000	1710000	1710000
operating profit	7580000	7580000	7580000	7580000	7580000
less tax-22%	1667600	1667600	1667600	1667600	1667600
after tax profit	5912400	5912400	5912400	5912400	5912400
add annual depreciation	1710000	1710000	1710000	1710000	1710000
annual operating cash flow	7622400	7622400	7622400	7622400	7622400
add recovery of working capital					910000
after tax sale proceeds with tax credit on loss of disposal of plant					2431200
net operating cash flow	7622400	7622400	7622400	7622400	10963600
E-NPV
Year	cash flow	present value factor at 12.51% =1/(1+r)^n r =12.51% n=1,2,3,4,5	present value of cash flow =cash flow*present value factor
0	-22360000	1	-22360000
1	7622400	0.888809884	6774864.5
2	7622400	0.789983009	6021566.5
3	7622400	0.702144706	5352027.8
4	7622400	0.624073155	4756935.2
5	10963600	0.554682388	6081315.8
NPV=sum of present value of cash flow			6626709.8
F-IRR
Year	cash flow
0	-22360000
1	7622400
2	7622400
3	7622400
4	7622400
5	10963600
IRR =Using IRR function in MS excel	IRR(F132:F137)	23.40%