Problem 14-30 Project Evaluation [LO3, 4] Suppose you have been hired as a financial consultant to...

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Problem 14-30 Project Evaluation [LO3, 4]
Suppose you have been hired as a financial consultant to DefenseElectronics, Inc. (DEI), a large, publicly traded firm that is themarket share leader in radar detection systems (RDSs). The companyis looking at setting up a manufacturing plant overseas to producea new line of RDSs. This will be a five-year project. The companybought some land three years ago for $2.8 million in anticipationof using it as a toxic dump site for waste chemicals, but it builta piping system to safely discard the chemicals instead. The landwas appraised last week for $5.9 million on an aftertax basis. Infive years, the aftertax value of the land will be $6.3 million,but the company expects to keep the land for a future project. Thecompany wants to build its new manufacturing plant on this land;the plant and equipment will cost $32.5 million to build. Thefollowing market data on DEI’s securities are current:
  Debt:
240,000 bonds with a coupon rate of 5.9 percent outstanding, 22years to maturity, selling for 104 percent of par; the bonds have a$1,000 par value each and make semiannual payments.
  Common stock:
9,400,000 shares outstanding, selling for $72.80 per share; thebeta is 1.25.
  Preferred stock:
460,000 shares of 3.7 percent preferred stock outstanding,selling for $82.75 per share. The par value is $100.
Market:
5.9 percent expected market risk premium; 2.8 percent risk-freerate.
DEI uses G.M. Wharton as its lead underwriter. Wharton chargesDEI spreads of 6.5 percent on new common stock issues, 4 percent onnew preferred stock issues, and 2 percent on new debt issues.Wharton has included all direct and indirect issuance costs (alongwith its profit) in setting these spreads. Wharton has recommendedto DEI that it raise the funds needed to build the plant by issuingnew shares of common stock. DEI’s tax rate is 21 percent. Theproject requires $1,450,000 in initial net working capitalinvestment to get operational. Assume DEI raises all equity for newprojects externally and that the NWC does not require floatationcosts..
a.
Calculate the project’s initial Time 0 cash flow, taking intoaccount all side effects. (A negative answer should beindicated by a minus sign. Do not roundintermediate calculations and enter your answer in dollars, notmillions of dollars, rounded to the nearest whole dollar amount,e.g., 1,234,567.)
b. The new RDS project is somewhat riskier than a typical projectfor DEI, primarily because the plant is being located overseas.Management has told you to use an adjustment factor of +1.0 percentto account for this increased riskiness. Calculate the appropriatediscount rate to use when evaluating DEI’s project. (Do notround intermediate calculations and enter your answer as a percentrounded to 2 decimal places, e.g., 32.16.)
c. The manufacturing plant has an eight-year tax life, and DEIuses straight-line depreciation to a zero salvage value. At the endof the project (that is, the end of Year 5), the plant andequipment can be scrapped for $5.1 million. What is the aftertaxsalvage value of this plant and equipment?(Do not round intermediate calculationsand enter your answer in dollars, not millions of dollars, roundedto the nearest whole dollar amount, e.g., 1,234,567.)
d. The company will incur $7,400,000 in annual fixed costs. Theplan is to manufacture 19,525 RDSs per year and sell them at$11,060 per machine; the variable production costs are $9,675 perRDS. What is the annual operating cash flow (OCF) from thisproject? (Do not round intermediatecalculations and enter your answer in dollars, not millions ofdollars, rounded to the nearest whole dollar amount, e.g.,1,234,567.)
e. DEI’s comptroller is primarily interested in the impact ofDEI’s investments on the bottom line of reported accountingstatements. What will you tell her is the accounting break-evenquantity of RDSs sold for this project? (Do not roundintermediate calculations and round your answer to nearest wholenumber, e.g., 32.)
f.
Finally, DEI’s president wants you to throw all yourcalculations, assumptions, and everything else into the report forthe chief financial officer; all he wants to know is what the RDSproject’s internal rate of return (IRR) and net present value (NPV)are. (Do not round intermediate calculations. Enter yourNPV in dollars, not millions of dollars, rounded to 2 decimalplaces, e.g., 1,234,567.89. Enter your IRR as apercentrounded to 2 decimal places, e.g.,32.16.)

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Problem 14-30 Project Evaluation [LO3, 4]Suppose you have been hired as a financial consultant to DefenseElectronics, Inc. (DEI), a large, publicly traded firm that is themarket share leader in radar detection systems (RDSs). The companyis looking at setting up a manufacturing plant overseas to producea new line of RDSs. This will be a five-year project. The companybought some land three years ago for $2.8 million in anticipationof using it as a toxic dump site for waste chemicals, but it builta piping system to safely discard the chemicals instead. The landwas appraised last week for $5.9 million on an aftertax basis. Infive years, the aftertax value of the land will be $6.3 million,but the company expects to keep the land for a future project. Thecompany wants to build its new manufacturing plant on this land;the plant and equipment will cost $32.5 million to build. Thefollowing market data on DEI’s securities are current: Debt:240,000 bonds with a coupon rate of 5.9 percent outstanding, 22years to maturity, selling for 104 percent of par; the bonds have a$1,000 par value each and make semiannual payments. Common stock:9,400,000 shares outstanding, selling for $72.80 per share; thebeta is 1.25. Preferred stock:460,000 shares of 3.7 percent preferred stock outstanding,selling for $82.75 per share. The par value is $100.Market:5.9 percent expected market risk premium; 2.8 percent risk-freerate.DEI uses G.M. Wharton as its lead underwriter. Wharton chargesDEI spreads of 6.5 percent on new common stock issues, 4 percent onnew preferred stock issues, and 2 percent on new debt issues.Wharton has included all direct and indirect issuance costs (alongwith its profit) in setting these spreads. Wharton has recommendedto DEI that it raise the funds needed to build the plant by issuingnew shares of common stock. DEI’s tax rate is 21 percent. Theproject requires $1,450,000 in initial net working capitalinvestment to get operational. Assume DEI raises all equity for newprojects externally and that the NWC does not require floatationcosts..a.Calculate the project’s initial Time 0 cash flow, taking intoaccount all side effects. (A negative answer should beindicated by a minus sign. Do not roundintermediate calculations and enter your answer in dollars, notmillions of dollars, rounded to the nearest whole dollar amount,e.g., 1,234,567.)b.The new RDS project is somewhat riskier than a typical projectfor DEI, primarily because the plant is being located overseas.Management has told you to use an adjustment factor of +1.0 percentto account for this increased riskiness. Calculate the appropriatediscount rate to use when evaluating DEI’s project. (Do notround intermediate calculations and enter your answer as a percentrounded to 2 decimal places, e.g., 32.16.)c.The manufacturing plant has an eight-year tax life, and DEIuses straight-line depreciation to a zero salvage value. At the endof the project (that is, the end of Year 5), the plant andequipment can be scrapped for $5.1 million. What is the aftertaxsalvage value of this plant and equipment?(Do not round intermediate calculationsand enter your answer in dollars, not millions of dollars, roundedto the nearest whole dollar amount, e.g., 1,234,567.)d.The company will incur $7,400,000 in annual fixed costs. Theplan is to manufacture 19,525 RDSs per year and sell them at$11,060 per machine; the variable production costs are $9,675 perRDS. What is the annual operating cash flow (OCF) from thisproject? (Do not round intermediatecalculations and enter your answer in dollars, not millions ofdollars, rounded to the nearest whole dollar amount, e.g.,1,234,567.)e.DEI’s comptroller is primarily interested in the impact ofDEI’s investments on the bottom line of reported accountingstatements. What will you tell her is the accounting break-evenquantity of RDSs sold for this project? (Do not roundintermediate calculations and round your answer to nearest wholenumber, e.g., 32.)f.Finally, DEI’s president wants you to throw all yourcalculations, assumptions, and everything else into the report forthe chief financial officer; all he wants to know is what the RDSproject’s internal rate of return (IRR) and net present value (NPV)are. (Do not round intermediate calculations. Enter yourNPV in dollars, not millions of dollars, rounded to 2 decimalplaces, e.g., 1,234,567.89. Enter your IRR as apercentrounded to 2 decimal places, e.g.,32.16.)

Debt:	240,000 bonds with a coupon rate of 5.9 percent outstanding, 22years to maturity, selling for 104 percent of par; the bonds have a$1,000 par value each and make semiannual payments.

Common stock:	9,400,000 shares outstanding, selling for $72.80 per share; thebeta is 1.25.

Preferred stock:	460,000 shares of 3.7 percent preferred stock outstanding,selling for $82.75 per share. The par value is $100.

Market:	5.9 percent expected market risk premium; 2.8 percent risk-freerate.

a.	Calculate the project’s initial Time 0 cash flow, taking intoaccount all side effects. (A negative answer should beindicated by a minus sign. Do not roundintermediate calculations and enter your answer in dollars, notmillions of dollars, rounded to the nearest whole dollar amount,e.g., 1,234,567.)
b.	The new RDS project is somewhat riskier than a typical projectfor DEI, primarily because the plant is being located overseas.Management has told you to use an adjustment factor of +1.0 percentto account for this increased riskiness. Calculate the appropriatediscount rate to use when evaluating DEI’s project. (Do notround intermediate calculations and enter your answer as a percentrounded to 2 decimal places, e.g., 32.16.)
c.	The manufacturing plant has an eight-year tax life, and DEIuses straight-line depreciation to a zero salvage value. At the endof the project (that is, the end of Year 5), the plant andequipment can be scrapped for $5.1 million. What is the aftertaxsalvage value of this plant and equipment?(Do not round intermediate calculationsand enter your answer in dollars, not millions of dollars, roundedto the nearest whole dollar amount, e.g., 1,234,567.)
d.	The company will incur $7,400,000 in annual fixed costs. Theplan is to manufacture 19,525 RDSs per year and sell them at$11,060 per machine; the variable production costs are $9,675 perRDS. What is the annual operating cash flow (OCF) from thisproject? (Do not round intermediatecalculations and enter your answer in dollars, not millions ofdollars, rounded to the nearest whole dollar amount, e.g.,1,234,567.)
e.	DEI’s comptroller is primarily interested in the impact ofDEI’s investments on the bottom line of reported accountingstatements. What will you tell her is the accounting break-evenquantity of RDSs sold for this project? (Do not roundintermediate calculations and round your answer to nearest wholenumber, e.g., 32.)
f.	Finally, DEI’s president wants you to throw all yourcalculations, assumptions, and everything else into the report forthe chief financial officer; all he wants to know is what the RDSproject’s internal rate of return (IRR) and net present value (NPV)are. (Do not round intermediate calculations. Enter yourNPV in dollars, not millions of dollars, rounded to 2 decimalplaces, e.g., 1,234,567.89. Enter your IRR as apercentrounded to 2 decimal places, e.g.,32.16.)