Retlaw Corporation (RC) manufactures time series photographic equipment. It is currently at its target debt equity ratio

Question:

Retlaw Corporation (RC) manufactures time series photographic equipment. It is currently at its target debt equity ratio of .80. It’s considering building a new $50 million manufacturing facility. This new plant is expected to generate after-tax cash flows of $6.2 million in perpetuity. The company raises all equity from outside financing. There are three financing options:

1. A new issue of common stock: The flotation costs of the new common stock would be 8 percent of the amount raised. The required return on the company’s new equity is 14 percent.

2. A new issue of 20-year bonds: The flotation costs of the new bonds would be 4 percent of the proceeds. If the company issues these new bonds at an annual coupon rate of 8 percent, they will sell at par.

3. Increased use of accounts payable financing: Because this financing is part of the company’s ongoing daily business, it has no flotation costs, and 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 .15. (Assume there is no difference between the pre-tax and after-tax accounts payable cost.) What is the NPV of the new plant? Assume that RC has a 35 percent tax rate.

Common Stock
Common stock is an equity component that represents the worth of stock owned by the shareholders of the company. The common stock represents the par value of the shares outstanding at a balance sheet date. Public companies can trade their stocks on... Accounts Payable
Accounts payable (AP) are bills to be paid as part of the normal course of business.This is a standard accounting term, one of the most common liabilities, which normally appears in the balance sheet listing of liabilities. Businesses receive... Corporation
A Corporation is a legal form of business that is separate from its owner. In other words, a corporation is a business or organization formed by a group of people, and its right and liabilities separate from those of the individuals involved. It may... Coupon
A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity. Coupons are usually referred to in terms of the coupon rate (the sum of coupons paid in a...

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