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FIN - Suppose you have been hired as a financial consultant to Defense Electronics Systems




Question;Suppose you have been hired as a financial consultant to Defense Electronics Systems (DES), a large publicly traded firm that is the market 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 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 company sold the land today, it would receive $6.5 million after taxes. In five years the land can be sold for $4.5 million after taxes and reclamation costs. The company wants to build its new manufacturing plant on this land, the plant will cost $15 million to build. The following market data on DES?s security are current:Debt: 5,000 7% coupon bonds outstanding, 15 years to maturity, selling for 92 percent of par, the bonds have a $1000 par value each and make semiannual payments.Common stock: 300,000 shares outstanding selling for $75 per share, the beta is 1.3.Preferred stock: 20,000 shares of 5% preferred stock outstanding selling for $72 per share with par of $100.Market: 8% expected market risk premium, 5% risk free rate.DES?s tax rate is 35%. The project requires $900,000 in initial working capital investment to become operational.a. Calculate the project?s initial cash flow taking into consideration all side effects.b. The new RDS project is somewhat riskier than a typical project for DES, primarily because the plant is located overseas. Management has told you to use an adjustment factor of +2% to account for this increased riskiness. Calculate the appropriate discount rate to use for evaluating this project.c. The manufacturing plant has an eight year tax life and DES uses straight line depreciation. At the end of the project (i.e., the end of year 5) the plant can be scrapped for $5 million. What is the after tax salvage value of this manufacturing plant?d. The company will incur $400,000 in annual fixed costs. The plan is to manufacture 12,000 RDSs per year and sell them at $10,000 per machine, the variable production costs are $9,000 per RDS. What is the annual operating cash flow (OCF) from this project?DEI?s president wants you to throw all your calculations, assumptions and everything else into a report for the CFO, all he wants to know is the RDS project?s IRR and NPV. What will you report?


Paper#48323 | Written in 18-Jul-2015

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