Question

Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt-equity ratio of .62. It’s considering building a new $65.2 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $7.84 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 15.2 percent.
b.	A new issue of 20-year bonds: If the company issues these new bonds at an annual coupon rate of 7.3 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 .10. (Assume there is no difference between the pretax and aftertax accounts payable cost.)

Answer 1

The debt of the company = Long-term debt + Accounts payable.

We can use the target ratio to calculate weight

The weight of each will be:

Acc. payable weight = .10/1.10 = 0.09

Long-term debt weight = 1/1.1 = 0.91

Then we can use the debt–equity ratio to calculate the weights of equity and debt.

RWACC = (1 / 1.62) (0.152) + (0.62 / 1.62) [(0.10 / 1.1) RWACC + (1 / 1.1) (.073) (1 – 0.22)]

Solving for WACC, we find:

RWACC = 0.0938 + 0.3827[(0.10 / 1.1) RWACC + .0518]

RWACC = .0938 + (.0348) RWACC + 0.0198

(0.9652) RWACC = 0.1136

RWACC = 0.1177, or 11.77%

The total amount to raise to fund the new manufacturing facility will be:

Amount raised = $65200000

This cash flows are for perpetuity.

The NPV is:

NPV = ($7840000 / 0.1177) - 65200000

NPV = $1410025.49