Chapter 14, Problem 28QP

Flotation Costs and NPV [LO3, 4] Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt–equity ratio of .60. It’s considering building a new $65 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $9.4 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 8 percent of the amount raised. The required return on the company’s new equity is 14 percent.

2. A new issue of 20-year bonds: The flotation costs of the new bonds would be 4 percent of the proceeds. If the company issues these new bonds at an annual coupon rate of 8 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 .15. (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 35 percent tax rate.