Suppose you have been hired as a financial consultant to Defense Electronics, Incorporated (DEI), a large, publicly traded firm that is the market share leader in radar detection systems (RDSS). The company is looking at setting up a manufacturing plant overseas to produce a new line of RDSS. This will be a five-year project. The company bought some land three years ago for $7.2 million in anticipation of using it as a toxic dump site for waste chemicals, but it built a piping system to safely discard the chemicals instead. If the land were sold today, the net proceeds would be $7.71 million after taxes. In five years, the land will be worth $8.01 million after taxes. The company wants to build its new manufacturing plant on this land; the plant will cost $13.44 million to build. The following market data on DEI's securities are current: Debt: Common stock: Preferred stock: Market: 92,200 6.9 percent coupon bonds outstanding, 23 years to maturity, selling for 93.9 percent of par; the bonds have a $1,000 par value each and make semiannual payments. 1,700,000 shares outstanding, selling for $95.10 per share; the beta is 1.18. 80,000 shares of 6.25 percent preferred stock outstanding, selling for $93.10 per share. 7.15 percent expected market risk premium; 5.05 percent risk-free rate. DEI's tax rate is 21 percent. The project requires $880,000 in initial net working capital investment to get operational. a. Calculate the project's Time O cash flow, taking into account all side effects. Assume that any NWC raised does not require floatation costs. Note: A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567. b. The new RDS project is somewhat riskier than a typical project for DEI, primarily because the plant is being located overseas. Management has told you to use an adjustment factor of +2 percent to account for this increased riskiness. Calculate the appropriate discount rate to use when evaluating DEI's project. Note: Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16. c. The manufacturing plant has an eight-year tax life, and DEI uses straight-line depreciation. At the end of the project (ie., the end of Year 5), the plant can be scrapped for $1.61 million. What is the aftertax salvage value of this manufacturing plant? Note: Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567. d. The company will incur $2,410,000 in annual fixed costs. The plan is to manufacture 14,100 RDSS per year and sell them at $11,500 per machine; the variable production costs are $10,700 per RDS. What is the annual operating cash flow, OCF, from this project? Note: Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567. e. Calculate the project's net present value. Note: Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89 f. Calculate the project's internal rate of return. Note: Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16. a. Time 0 cash flow b. Discount rate c. Aftertax salvage value d. Operating cash flow e. NPV f. IRR % %

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
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Suppose you have been hired as a financial consultant to Defense Electronics, Incorporated (DEI), a large, publicly traded firm that is
the market share leader in radar detection systems (RDSS). The company is looking at setting up a manufacturing plant overseas to
produce a new line of RDSS. This will be a five-year project. The company bought some land three years ago for $7.2 million in
anticipation of using it as a toxic dump site for waste chemicals, but it built a piping system to safely discard the chemicals instead. If
the land were sold today, the net proceeds would be $7.71 million after taxes. In five years, the land will be worth $8.01 million after
taxes. The company wants to build its new manufacturing plant on this land; the plant will cost $13.44 million to build. The following
market data on DEI's securities are current:
Debt:
Common stock:
Preferred stock:
Market:
92,200 6.9 percent coupon bonds outstanding, 23 years to
maturity, selling for 93.9 percent of par; the bonds have a
$1,000 par value each and make semiannual payments.
1,700,000 shares outstanding, selling for $95.10 per share; the
beta is 1.18.
80,000 shares of 6.25 percent preferred stock outstanding,
selling for $93.10 per share.
7.15 percent expected market risk premium; 5.05 percent risk-free
rate.
DEI's tax rate is 21 percent. The project requires $880,000 in initial net working capital investment to get operational.
a. Calculate the project's Time O cash flow, taking into account all side effects. Assume that any NWC raised does not require
floatation costs.
Note: A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answer in
dollars, not millions of dollars, e.g., 1,234,567.
b. The new RDS project is somewhat riskier than a typical project for DEI, primarily because the plant is being located overseas.
Management has told you to use an adjustment factor of +2 percent to account for this increased riskiness. Calculate the
appropriate discount rate to use when evaluating DEI's project.
Note: Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.
c. The manufacturing plant has an eight-year tax life, and DEI uses straight-line depreciation. At the end of the project (i.e., the end of
Year 5), the plant can be scrapped for $1.61 million. What is the aftertax salvage value of this manufacturing plant?
Note: Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567.
d. The company will incur $2,410,000 in annual fixed costs. The plan is to manufacture 14,100 RDSS per year and sell them at $11,500
per machine; the variable production costs are $10,700 per RDS. What is the annual operating cash flow, OCF, from this project?
Note: Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567.
e. Calculate the project's net present value.
Note: Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal
places, e.g., 1,234,567.89
f. Calculate the project's internal rate of return.
Note: Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.
a. Time 0 cash flow
b. Discount rate
c. Aftertax salvage value
d. Operating cash flow
e. NPV
f. IRR
%
%
Transcribed Image Text:Suppose you have been hired as a financial consultant to Defense Electronics, Incorporated (DEI), a large, publicly traded firm that is the market share leader in radar detection systems (RDSS). The company is looking at setting up a manufacturing plant overseas to produce a new line of RDSS. This will be a five-year project. The company bought some land three years ago for $7.2 million in anticipation of using it as a toxic dump site for waste chemicals, but it built a piping system to safely discard the chemicals instead. If the land were sold today, the net proceeds would be $7.71 million after taxes. In five years, the land will be worth $8.01 million after taxes. The company wants to build its new manufacturing plant on this land; the plant will cost $13.44 million to build. The following market data on DEI's securities are current: Debt: Common stock: Preferred stock: Market: 92,200 6.9 percent coupon bonds outstanding, 23 years to maturity, selling for 93.9 percent of par; the bonds have a $1,000 par value each and make semiannual payments. 1,700,000 shares outstanding, selling for $95.10 per share; the beta is 1.18. 80,000 shares of 6.25 percent preferred stock outstanding, selling for $93.10 per share. 7.15 percent expected market risk premium; 5.05 percent risk-free rate. DEI's tax rate is 21 percent. The project requires $880,000 in initial net working capital investment to get operational. a. Calculate the project's Time O cash flow, taking into account all side effects. Assume that any NWC raised does not require floatation costs. Note: A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567. b. The new RDS project is somewhat riskier than a typical project for DEI, primarily because the plant is being located overseas. Management has told you to use an adjustment factor of +2 percent to account for this increased riskiness. Calculate the appropriate discount rate to use when evaluating DEI's project. Note: Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16. c. The manufacturing plant has an eight-year tax life, and DEI uses straight-line depreciation. At the end of the project (i.e., the end of Year 5), the plant can be scrapped for $1.61 million. What is the aftertax salvage value of this manufacturing plant? Note: Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567. d. The company will incur $2,410,000 in annual fixed costs. The plan is to manufacture 14,100 RDSS per year and sell them at $11,500 per machine; the variable production costs are $10,700 per RDS. What is the annual operating cash flow, OCF, from this project? Note: Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567. e. Calculate the project's net present value. Note: Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89 f. Calculate the project's internal rate of return. Note: Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16. a. Time 0 cash flow b. Discount rate c. Aftertax salvage value d. Operating cash flow e. NPV f. IRR % %
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