Question

Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt-equity ratio of .65. It’s considering building a new $69 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $6.9 million in perpetuity. The company raises all equity from outside financing. There are three financing options:

1. A new issue of common stock: The flotation costs of the new common stock would be 7.1 percent of the amount raised. The required return on the company’s new equity is 12 percent.

2. A new issue of 20-year bonds: The flotation costs of the new bonds would be 2.3 percent of the proceeds. If the company issues these new bonds at an annual coupon rate of 4 percent, they will sell at par.

3. 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 22 percent tax rate. (Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to the nearest whole dollar amount, e.g., 1,234,567.)

Answer 1

		Weighted Average Cost of Capital (WACC)
		Debt/Equity=0.65
		Debt=0.65*Equity
		Total Capital=Debt+Equity=1.65*Equity
	We	Weight of Equity =1/1.65=	0.606060606
	Wd	Weight of Debt =0.65/1.65=	0.393939394
		Accounts Payable /Long Term Debt=0.2
		Accounts Payable =0.2*Long Term Debt
		Total Debt =1.2 *Long Term Debt
		Long Term Debt =Total Debt/1.2
	Wld	Weight of Long Term Debt=0.393939/1.2=	0.328282828
	Wa	Accounts Payable =0.2*0.328283	0.065656566
	Ce	Cost of Equity=(12/(1-0.071))%	12.92%
		Before tax Cost of Debt=4/(1-0.023)=	4.09%
	Cd	After tax cost of debt=4.09*(1-Tax Rate)	3.19%	(4.09*(1-0.22)
		WACC=We*Ce+Wld*Cd+WACC*Wa
		WACC=WE*Ce+Wld*Cd+WACC*Wa
		WACC=0.078286+0.010484+WACC*0.065657
		WACC*(1-0.065657)=	0.088769092
		WACC=	0.09500692
		WACC in percentage	9.50%
		Annual after tax cash flow in perpetuity($ million)	$6.90
	PV	Present Value of Cash Inflows in perpetuity=6.9/0.0950	$72.631579	(Million)
	IC	Initial Cash outflow($ million)	($69)
	NPV=PV+IC	Net Present Value (NPV)=72.63-69=	$3.631579	Million
		Net Present Value (NPV)=	$3,631,579