Suppose you have been hired as a financial consultant to Defense Electronics, In
ID: 2645514 • Letter: S
Question
Suppose you have been hired as a financial consultant to Defense Electronics, Inc. (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 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 $7.67 million after taxes. In five years, the land will be worth $7.97 million after taxes. The company wants to build its new manufacturing plant on this land; the plant will cost $13.28 million to build. The following market data on DEI
Explanation / Answer
Requirnment 1 : We will not consider the purchase value of the land and we will treat it as sunk cost.
Plant cost: $ 13,280,000
Add : Working capital: $ 860,000
Cash Flow required at Time 0 = 14,140,000
Requirnment 2: We will have to identify the WAC of capital.
1) Bonds: Interest Paid net of tax 45700x1000x7% = 3199000 (1-.3)=2239300
45700*943=43095100
??2239300 / 4395100 = 5.2%
2) Comman Sock : rf + (rp-rf)b
5.3+1.27(7.1-5.3) = 7.58%
3) Prefer shares : 6.3 / 92.7 = 6.8%
WAC of capital
Now the business is more risky +3% to be added to WAC of capital calculated above = 9.69%
Requirnment 3 : scrape value = 1570000
after tax 1570000x.7=1099000
discounted value after 5 year of WACof capital calcuated 1/1.0969 repeat it for 5 times = .6297
discounted value will be = 109900 x.6297= 692089.89
Requirnment 4: Contribution total = (11100-10300) 13700 = 1096000
less : fixed cost = 2370000
Operating cash flow wil be = 8590000
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