You get hired as the CFO of a large, Danish company that manufactures bulletproof vests. You are appointed by the board of directors to serve the interest of the shareholders. As the CFO, you are considering to invest in the development of a new line of vests known as the Mariachi Vest. You know little about your company, except that it is a firm traded on Nasdaq OMX, and its stock is quite risky according to the estimated beta of the firm, which is 1.60. Thus, the first thing you do when you start your analyses is to look at the firm's capital structure. You see that it is 75% financed by debt, and debt holders require a 5% rate of return on their investment. The cost of constructing the plant for developing the vest is DKK 50,000,000 upfront. The plant then would have an expected life of 10 years. The firm expects to sell 4000 vests a year till the plant closes down. All the expenditure made for the plant today will be depreciated straight-line over 10 years (from year 1 to year 10) to a salvage value of 10 million DKK, but they expect to sell the plant after 10 years for 15 million DKK. If it works, it will generate DKK 7,000,000 per year for 10 years. Taxes are 21%. The interest on short-term government bonds is 4%, while the overall Nasdaq OMX stock market returned 8% last year, and that is expected to continue. Also, importantly, you quickly realize that this project is a typical investment project of your company. What is the project’s NPV under these assumptions? Should the firm invest in the project?

SWFT Individual Income Taxes

43rd Edition

ISBN:9780357391365

Author:YOUNG

Publisher:YOUNG

Chapter16: Property Transactions: Capital Gains And Losses

Section: Chapter Questions

Problem 24P

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You get hired as the CFO of a large, Danish company that manufactures bulletproof vests. You are appointed by the board of directors to serve the interest of the shareholders. As the CFO, you are considering to invest in the development of a new line of vests known as the Mariachi Vest. You know little about your company, except that it is a firm traded on Nasdaq OMX, and its stock is quite risky according to the estimated beta of the firm, which is 1.60. Thus, the first thing you do when you start your analyses is to look at the firm's capital structure. You see that it is 75% financed by debt, and debt holders require a 5% rate of return on their investment. The cost of constructing the plant for developing the vest is DKK 50,000,000 upfront. The plant then would have an expected life of 10 years. The firm expects to sell 4000 vests a year till the plant closes down. All the expenditure made for the plant today will be depreciated straight-line over 10 years (from year 1 to year 10) to a salvage value of 10 million DKK, but they expect to sell the plant after 10 years for 15 million DKK. If it works, it will generate DKK 7,000,000 per year for 10 years. Taxes are 21%. The interest on short-term government bonds is 4%, while the overall Nasdaq OMX stock market returned 8% last year, and that is expected to continue. Also, importantly, you quickly realize that this project is a typical investment project of your company.

What is the project’s NPV under these assumptions? Should the firm invest in the project?

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