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 $7.66 million after taxes. In five years, the land will be worth $7.96 million after taxes. The company wants to build its new manufacturing plant on this land; the plant will cost $13.24 million to build. The following market data on DEI's securities are current: Debt: Common stock: Preferred stock: Market: 91,200 6.9 percent coupon bonds outstanding, 23 years to maturity, selling for 94.4 percent of par; the bonds have a $1,000 par value each and make semiannual payments. 1,600,000 shares outstanding, selling for $94.60 per share; the beta is 1.26. 75,000 shares of 6.25 percent preferred stock outstanding, selling for $92.60 per share. 6.85 percent expected market risk premium; 5.15 percent risk-free rate. DEI's tax rate is 21 percent. The project requires $855,000 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 +3 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 $1.56 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 $2,360,000 in annual fixed costs. The plan is to manufacture 13,600 RDSs per year and sell them at $11,000 per machine; the variable production costs are $10,200 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 $ -21,755,000 b. Discount rate 13.77 % c. Aftertax salvage value $ 2,275,050 ✓ d. Operating cash flow $ 7,601,650 x e. NPV $ 52,360,848.62 × f. IRR 32.38%

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 $7.66 million after taxes. In five years, the land will be worth $7.96 million after taxes. The company wants to build its new manufacturing plant on this land; the plant will cost $13.24 million to build. The following market data on DEI's securities are current: Debt: Common stock: Preferred stock: Market: 91,200 6.9 percent coupon bonds outstanding, 23 years to maturity, selling for 94.4 percent of par; the bonds have a $1,000 par value each and make semiannual payments. 1,600,000 shares outstanding, selling for $94.60 per share; the beta is 1.26. 75,000 shares of 6.25 percent preferred stock outstanding, selling for $92.60 per share. 6.85 percent expected market risk premium; 5.15 percent risk-free rate. DEI's tax rate is 21 percent. The project requires $855,000 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 +3 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 $1.56 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 $2,360,000 in annual fixed costs. The plan is to manufacture 13,600 RDSs per year and sell them at $11,000 per machine; the variable production costs are $10,200 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 $ -21,755,000 b. Discount rate 13.77 % c. Aftertax salvage value $ 2,275,050 ✓ d. Operating cash flow $ 7,601,650 x e. NPV $ 52,360,848.62 × f. IRR 32.38%

Cornerstones of Cost Management (Cornerstones Series)

4th Edition

ISBN:9781305970663

Author:Don R. Hansen, Maryanne M. Mowen

Publisher:Don R. Hansen, Maryanne M. Mowen

Chapter19: Capital Investment

Section: Chapter Questions

Problem 30P: Mallette Manufacturing, Inc., produces washing machines, dryers, and dishwashers. Because of...

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