Question

Macon Inc. is looking at setting up a manufacturing plant in Kirksville. This will be a 6-year project. The company bought the land in Kirksville last year for $1.5 million in anticipation of using it as a warehouse. The land is now appraised for $1.7 million after-tax. In 6 years, the after-tax value of the land is estimated for $2 million. The plant and equipment will cost $9.3 million to build and will be depreciated straight-line to zero over the project's 6-year life. To operate the plant and equipment, workers would have to go through a brief training session that would cost $100,000 after tax. In addition, it would cost $300,000 after-tax to install the equipment properly. The plant and equipment will require the firm to increase account payables and inventory by $100,000, respectively, and decrease account receivables by $200,000. The equipment can be sold for $1 million (before-tax) at the end of the project. The plant will raise sales by $3 million annually and reduce production expenses by $2 million annually.

The plant and equipment will be externally financed. The flotation cost of equity is estimated to be 7.2% and the flotation cost of debt is estimated to be 3%. The company has a target debt to equity ratio of 0.2. The company’s tax rate is 20%. Finally, the following market data on Macon Inc.’s securities are current:

Common stock: Macon Inc's expected dividend payment next year is projected to be $3.00 per share, and dividends are expected to grow at a 4 percent annual rate indefinitely. The stock sells for $60 a share.

Debt: Macon Inc. issued a 25-year, 6 percent, semiannual bond 8 years ago. The bond sells for 100 percent of its face value.

(a) (15 points) What is the Macon Inc’s WACC?

(b) (20 points) What is the NPV of this project?

Answer 1

a)

b)