Suppose you have been hired as a financial consultant to Defense Electronics, In
ID: 2645653 • 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 $7.66 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
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 $7.66 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
Explanation / Answer
Calculation of Cost of Equity for Common Stock
Ke= Rf+ Beta of stock ( Market Risk Premium)
Ke= 5.25+1.26(7.05)
Ke=14.13 %
Calculation of WACC
Particulars
No of Bonds/ Stock
Market Price
Market Value
Weight
Cost
WACC
Bonds
45600
944
43046400
36.52
.0455
1.66
Preferred Stock
35600
92.6
3296560
2.797
.0625
0.1748
Common Stock
756000
94.6
71517600
60.679
0.1433
8.695
TOTAL
10.53
Discounting rate 10.53 % will be used for calculation of NPV.
Discounting Factor year wise @ 10.53
0
1
2
3
4
5
1
9.047
8.185
7.405
6.7
6.06
Calculation of Net Present Value of Project for Manufacturing a Plant
Present Value of Sale Value of Land sold in 5th Year
(7.96X6.06)
1.3135
Plant cost ( 13.24 X 1)
13.24
Present Value of Initial Working Capital (0.855 X1 )
0.855
Net Present Value ( 1-2-3)
12.78
Net present value of outflow will be $12.78.
IRR
This is rate of return which is used as discounted rate of return for calculation of net present value, where net present value is equal to zero.
For sany preoject, where IRR is grater than WACC , project should be accepted. If IRR is less than WACC , project should be rejected.
Particulars
No of Bonds/ Stock
Market Price
Market Value
Weight
Cost
WACC
Bonds
45600
944
43046400
36.52
.0455
1.66
Preferred Stock
35600
92.6
3296560
2.797
.0625
0.1748
Common Stock
756000
94.6
71517600
60.679
0.1433
8.695
TOTAL
10.53
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