You have been hired as a financial consultant to Tamar Circuitry Ltd

You have been hired as a financial consultant to Tamar Circuitry Ltd (TCL), a large publicly traded firm that is the market share leader in radar detection systems (RDS). The company is looking at setting up a manufacturing plant overseas to produce a new line of RDS’s. This will be a five year project. The company bought some land three years ago for $4 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. The land was appraised last week for $5.1 million. In five years, the after tax value of the land will be $6 million, but the company expects to keep the land for a future project. The company wants to build its new manufacturing plant on this land; the plant and equipment will cost $35 million to build. The following market data on TCL’s securities are current:

Debt: 240,000 7.5 percent coupon bonds outstanding, 20 years to maturity, currently trading at $940; the bonds have a $1,000 par value each and make semi-annual payments.

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Ordinary Share: 9,000,000 shares outstanding, selling for $71 per share; the beta is 1.2.

Preference Share: 400,000 shares of 5.5 percent preferred stock outstanding, with a face value of $100, selling for $81 per share.

Market: 8 percent market risk premium; 5 percent risk – free rate.

TCL uses Shylock Ltd as its lead underwriter. Shylock charges spreads/flotation costs of 8 percent on new share issues, 6 percent on new preference share issues and 4 percent on debt issues. Shylock has included all direct and indirect issuance costs (along with its profits) in setting these spreads/flotation costs. TCL’s tax rate is 35 percent. The project requires

$1,300,000 in initial net working capital investment to reach operational stage. Assume Shylock raises all additional financing needed for new projects externally.

Required

1. Calculate the project’s initial investment at time 0, taking into account all side effects including weighted flotation costs. [1.5 marks]
2. The new RDS project is somewhat riskier than a typical project for TCL, primarily because the plant is located overseas. Management has told you to use an adjustment factor of + 2 percent to account for this increased riskiness. Calculate the appropriate discount rate to use when evaluating TCL’s project. [2 marks]
3. The manufacturing plant has an eight year tax life, and TCL uses straight line depreciation. At the end of the project (that is, the end of year 5), the plant and equipment can be scrapped for $6 million dollars. What is the after tax salvage value of this plant and equipment? [1 mark]
4. The company will incur $7,000,000 in annual fixed costs. The plan is to manufacture 18,000 RDS’s per year and sell them at $10,900 per machine; the variable production costs are $9,400 per RDS. What is the annual operating cash flow (OCF) from this project? [1 mark]
5. TCL’s financial controller is primarily interested in the impact of TCL’s investments on the bottom line of reported accounting statements. What will you tell her is the accounting break even quantity of RDS’s sold for this project?

[1 mark]

1. Finally, TCL’s chief executive officer (CEO) wants you to prepare a draft report only showing what the RDS project’s internal rate of return (IRR) and net present value (NPV). [3 marks]
2. What will you report to the CEO? Include in your response to him the reasons why the NPV and IRR methods may give different answers in terms of accepting or rejecting projects. Explain the reasons for the conflict, and discuss how the conflict can be resolved. (250 words)