Question

Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt–equity ratio of .58. It’s considering building a new $71.1 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $7.86 million in perpetuity. There are three financing options:

A new issue of common stock: The required return on the company’s new equity is 15.3 percent.

A new issue of 20-year bonds: If the company issues these new bonds at an annual coupon rate of 7.1 percent, they will sell at par.

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 .10. (Assume there is no difference between the pretax and aftertax accounts payable cost.)

If the tax rate is 34 percent, what is the NPV of the new plant? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Round your answer to 2 decimal places, e.g., 32.16.)

Net present value            $

Answer 1

First, we need to calculate the WACC whoch we will use as the discount rate

Debt = 0.58* Equity

Total of equity = 1/1.58 *71,100,000 = 45,000,000

Total Debt = 71,100,000 - 45,000,000 = 26,100,000

Weight of Equity = 45/71.1 = 0.6329

Weight of Debt = 1-0.6329 =0.3671

Cost of equity = 15.3%

After tax cost of debt = 7.1%*(1-0.34) = 4.686%

WACC = 0.6329*15.3% +0.3671*4.686% = 11.4036%

Additional Accounts payable = 0.15*26,100,000 = 3,915,000

This will have the same cost of WACC

NPV = 7,860,000/0.114036 - 3,915,000/0.114036 - 71,100,000 = -$36,505,661.37 (negative)