Question

Landman Corporation (LC) manufactures time series photographic equipment. It is currently at its target debt-equity ratio of .69. It's considering building a new $65.9 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $7.41 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 15.1 percent. b. A new issue of 20-year bonds. If the company issues these new bonds at an annual coupon rate of 7.4 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 .11. (Assume there is no difference between the pretax and aftertax accounts payable cost.)
If the tax rate is 24 percent, what is the NPV of the new plant?
Note: 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, rounded to 2 decimal places, e.g., 1,234,567.89.
Net present value

Answer 1

The NPV of the new plant for Landman Corporation cannot be accurately calculated without the cost of accounts payable financing or the overall firm's WACC. Calculation of NPV would require the present value of aftertax cash flows discounted at the cost of each financing option. However, with the given data, only the equity and bond options' NPV calculations could be approached, not the accounts payable option.

Step-by-step explanation:

To calculate the net present value (NPV) of the new plant for Landman Corporation, we first need to estimate the present value (PV) of the perpetual cash flows it expects to generate using each financing option.

Aftertax cash flows

are given to be $7.41 million in perpetuity. Option a suggests issuing new equity at a required return of 15.1%. The NPV using this option can be calculated using the formula: NPV = Cash Flow / Required Return. For option b, the company would issue 20-year bonds at a coupon rate of 7.4%; however, since the cash flows from the plant are perpetual, the coupon rate will be used as the discount rate for the NPV calculation similar to perpetual bonds. Option c uses accounts payable financing, and we'll need to know the weighted average cost of capital (WACC) to determine the cost for this option, although it's not provided in the question. We know the

tax rate

is 24%, but we have insufficient information to calculate the cost of accounts payable financing or the overall WACC without additional data. Therefore, we cannot calculate the NPV for option c without this. Due to the lack of data for some options, we cannot provide a definite answer for the NPV of the new plant.

Answer 2

The NPV of Landman Corporation's new manufacturing facility, if financed by issuing new common stock, would be -$16,827,150, indicating a reduction in the company's value.

Step-by-step explanation:

The Net Present Value (NPV) of Landman Corporation's new manufacturing facility can be calculated by determining the present value of the perpetual aftertax cash flows generated by the facility and subtracting the initial investment cost. The present value is found by dividing the expected perpetual cash flows of $7.41 million by the required return on equity of 15.1 percent, since option a suggests issuing new common stock and thereby not taking on any new debt. This calculation will not be affected by the cost of debt or accounts payable financing since new equity is being used. Therefore, the required return on new equity becomes the discount rate. The tax rate is not directly required in this calculation because the cash flows are already stated as aftertax. The NPV can be calculated as follows:

NPV = (Annual aftertax cash flows / Required return on new equity) - Initial investment cost

NPV = ($7.41 million / 0.151) - $65.9 million

NPV = $49.07285 million - $65.9 million

NPV = -$16.82715 million

Thus, if the new manufacturing facility is financed through new common stock issuance, the NPV of the investment would be -$16,827,150, which suggests that the investment would reduce the company's value by that amount.