Retlaw Corporation (RC) manufactures time-series photographic equipment. It is currently at its target debt-equity ratio of 0.88. It's considering building a new $49 million manufacturing facility. This new plant is expected to generate after-tax cash flows of $8.8 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 9% of the amount raised. The required return on the company's new equity is 15%. 2. A new issue of 20-year bonds: The flotation costs of the new bonds would be 4% of the proceeds. If the company issues these new bonds at an annual coupon rate of 8.0%, 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 0.140. (Assume there is no difference between the pre-tax and after-tax accounts payable cost.) What is the NPV of the new plant? Assume that RC has a 25% tax rate. (Enter the answer in dollars. Do not round intermediate calculations. Round the WACC percentage to 2 decimal places. Round the final answer to 2 decimal places. Omit $ sign in your response.) NPV
Retlaw Corporation (RC) manufactures time-series photographic equipment. It is currently at its target debt-equity ratio of 0.88. It's considering building a new $49 million manufacturing facility. This new plant is expected to generate after-tax cash flows of $8.8 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 9% of the amount raised. The required return on the company's new equity is 15%. 2. A new issue of 20-year bonds: The flotation costs of the new bonds would be 4% of the proceeds. If the company issues these new bonds at an annual coupon rate of 8.0%, 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 0.140. (Assume there is no difference between the pre-tax and after-tax accounts payable cost.) What is the NPV of the new plant? Assume that RC has a 25% tax rate. (Enter the answer in dollars. Do not round intermediate calculations. Round the WACC percentage to 2 decimal places. Round the final answer to 2 decimal places. Omit $ sign in your response.) NPV
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Question
Transcribed Image Text:Retlaw Corporation (RC) manufactures time-series photographic equipment. It is currently at its target debt-equity ratio of 0.88. It's
considering building a new $49 million manufacturing facility. This new plant is expected to generate after-tax cash flows of $8.8
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 9% of the amount raised. The required return
on the company's new equity is 15%.
2. A new issue of 20-year bonds: The flotation costs of the new bonds would be 4% of the proceeds. If the company issues these new
bonds at an annual coupon rate of 8.0%, 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 0.140. (Assume there is no difference between the pre-tax and after-tax accounts payable
cost.)
What is the NPV of the new plant? Assume that RC has a 25% tax rate. (Enter the answer in dollars. Do not round intermediate
calculations. Round the WACC percentage to 2 decimal places. Round the final answer to 2 decimal places. Omit $ sign in your
response.)
NPV
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