Question

Photochronograph corporation (pc) manufactures time series photographic equipment. it is currently at its target debt-equity ratio of .45. it's considering building a new $55 million manufacturing facility. this new plant is expected to generate aftertax cash flows of $7.4 million in perpetuity. there are three financing options:
a. a new issue of common stock: the required return on the company's new equity is 15 percent.
b. a new issue of 20-year bonds: if the company issues these new bonds at an annual coupon rate of 7 percent, they will sell at par.
c. increased use of accounts payable financing: because this financing is part of the company's ongoing daily business, 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.)

Answer 1

Answer: NPV: $8,430,000

Explanation:

Initial Investment: -$55,000,000

After Tax cash flows: $7,400,000

Calculation of the Weighted Average Cost of Capital:

Cost of Equity (ke) : 15%

Pre Tax Cost of Debt (kd): 7%

65 or 26.99% [/tex]

Since the tax rate is not given, let us assume tax rate to be 30%

Tax rate : 30%

Post tax long term debt = 7%*(1-0.30)

Post tax long term debt (kd) = 4.90%

Debt/Equity: 0.45 or 45%

$Weight of Equity = Equity / (Debt + Equity) Weight of Equity = 1 / (0.45 + 1) Weight of Equity (We) = 0.689655 or 68.97%$

$Weight of Total Debt = Debt/ (Debt + Equity) Weight of Total Debt = 0.45/(1+0.45) Weight of Total Debt = 0.310345 or 31.0345%$

Long term Debt to Accounts Payable ratio : 0.15

$Long term debt = 1/(1+0.15) Long term debt = 0.869565$

Weight of Long term debt for the purpose of calculation of Weighted Average cost of capital:

$Weight of Long Term debt = 0.310345 * 0.869565 Weight of Long Term Debt (Wd) = 0.2698$

Weighted Average Cost of Capital = Weight of Long term debt (Wd) * Post tax long term debt (kd)+ Weight of Equity (We)*Cost of equity (ke)

where, Wd = 26.9865%

We = 68.9655%

kd = 4.90%

ke = 15%

By input the variables, into the formula of WACC,$WACC = 4.90%*0.269865 + 15%*0.689655 WACC = 0.013223 + 0.103448 WACC = 0.1167 or 11.67%$

Using the WACC for the calculation of NPV:

NPV = Present Value of cash flows - Initial Investment.

$NPV = 7,400,000/0.1167 - 55,000,000 NPV = 63,430,000 - 55,000,000 NPV = 8,430,000$

Therefore NPV of the project is $8,430,000 assuming the tax rate to be 30%