Photochronograph Corporation (PC) manufactures time series
photographic equipment. It is currently at its target debt–equity
ratio of .61. It’s considering building a new $71.6 million
manufacturing facility. This new plant is expected to generate
aftertax cash flows of $7.91 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 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 .11. (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.)
GIven Debt Equity Ratio = 0.61
Debt Ratio = 0.61 / [ 0.61 + 1 ]
= 0.61 / 1.61
= 0.3789
Equity Ratio = 1 - 0.3789
= 0.6211
Long term Debt Wight = 0.3789 * 0.89
= 0.3372
Accounts payable weight = 0.3789 * 0.11
= 0.0417
Letus Assume WACC is "x"
Thus X = 0.1090 + 0.0417 X
0.9583 X = 0.1090
X = 0.1090 / 0.9583
= 0.1137
PV of Cash Flows = CF Per anum / WACC
= $ 7.91 M / 11.37%
= $ 69.57 M
NPV = PV of Cash Inflows - PV of Cash Outflows
= $ 69.57 M - $ 71.6 M
= - $ 2.03 M
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