Question

Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt-equity ratio of .85. It’s considering building a new $48 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: 1. 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. 2. A new issue of 20-year bonds: The flotation costs of the new bonds would be 2.6 percent of the proceeds. If the company issues these new bonds at an annual coupon rate of 5.5 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 costs. What is the NPV of the new plant? Assume that PC has a 25 percent tax rate. (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole dollar amount, e.g., 1,234,567.)

Answer 1

We have three ways of financing

Equity,debt,accounts payable

Therefore we will need weight of all three to calculate WACC

Step1

Calculation of weights

Given Debt:Equit=0.85

Debt=0.85

Equity=1

Total-=1.85

Therefore

Weight of Debt=0.85/1.85= 0.4595

Equity=1/1.85= 0.5405

Accounts payable to LTdebt

=0.2

Accounts payable =0.2/1.2=0.1667

Long term debt=1/1.2=0.8333

Step2

Now lets See what is the cost

Equity Ke=13% (given common stock)

Debt Kd=5.5%=

After tax kd 5.5(1-0.25)=4.125%

Accounts payable WACC= cost that is the same as the overall firm WACC. Assume it WACC

step4 calculation of wacc

WE*ke+WD1*wd2*kd1(after tax)+WAP*wd1*WACC(after tax)

0.5405*13%+ (0.4595*0.8333)(*4.125%)+(0.4595*0.1667)*WACC)

7.02650%+0.382901(4.125%)+0.076599(wacc)

7.02650%+1.579468%+0.076599WACC

8.605968%+0.076599WACC=WACC

0.923401 WACC=8.605968%

WACC=9.32%

step5 floatation cost

Calculation of floatation cost

0.5405*7%+ (0.4595*0.8333)(*2.6%)+(0.4595*0.1667)*0)

3.7835%+0.99554%+0

4.779%

Hence proceeds to be raised =48million/(1-4.779%)

=48000000/95.221%

=50409048

Step6 calculation of NPV

Npv=pv (present value)of perpetual cash flow-proceeds raised

=5200000/0.932

55793991-50409048

NPV=$5384943

Answer involves many steps please go through each carefully any doubt please ask anything not clear feel free to ask. Kindly give thumbs up it helps me.