Question

Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt-equity ratio of .8. It’s considering building a new $72 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $8.4 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 6.7 percent of the amount raised. The required return on the company’s new equity is 15 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 6 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 25 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

Financing Option-1				Common stock
Floatation cost				6.70%
Required return				15%
Fund required				72000000
Which is net of floation cost hence to amount required to raise.
Total fund required=				Fund after floation cost X 100
				100-% of floation cost
			=	72000000*100/100-6.7
			=	7,71,70,418.01
Revised required return=				Original Investment X Required rate of return
				Investment after floatation cost
			=	(77170418.01*15%)/72000000*100
			=	16.08
Present value of cash flow			=	8400000/16.08 *100
				5,22,38,805.97
Net present Value= present value of cash flow-Cost of building
	=	52238805.9701493-72000000
	=	-1,97,61,194.03
Financing Option-2				Bond
Floatation cost				2.60%
Required return				6%
Fund required				72
Which is net of floation cost hence to amount required to raise.
Total fund required=				Fund after floation cost X 100
				100-% of floation cost
			=	72000000*100/100-2.6
			=	7,39,21,971.25
Revised required return=				Original Investment X Required rate of return
				Investment after floatation cost
			=	(73921971.25*6%)/72000000*100
Pretax Rate			=	6.16
Post tax			=	6.16*.75
			=	4.62
Present value of cash flow Post Tax			=	8400000/4.62 *100
			=	136363636.4
Present value of cash flow Post Tax			=	8400000/4.62 *100
			=	181818181.8
Pre tax Net present Value= present value of cash flow-Cost of building
		=	136363636.36-72000000
			208363636
Post tax Net present Value= present value of cash flow-Cost of building
		=	181818181.82-72000000
		=	109818182
Financing Option-3				Accounts payable
Present Debt Equity ratio				0.8
Formula of debt equity			=	Total debt/ Equity
Project Cost				72000000
Total Financing		=	Debt +Equity
Total Financing		=	1.8
Debt		=	32000000
Equity		=	40000000
Total		=	72000000
Pre tax WaCC of Firm		=	(Equity weight * Rate of Return)+(Debt *Rate of interest)
Pre tax WaCC of Firm		=	((1*.15)+(.8*.06))*100
		=	19.8
Post Tax WaCC of Firm			(Equity weight * Rate of Return)+(Debt *Rate of interest after tax)
		=	((1*.15)+(.8*.06*.75))*100
		=	18.6
Present value of Cash flow			=	8400000/18.6 *100
				45161290.32
Net present Value			=	45161290.32-72000000
			=	-26838709.68