Purchase Solution

Project NPV

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You've been hired fresh off your Augsburg MBA as a financial consultant to the Mayo Clinic (MC), a new, for-profit, publicly traded firm that is the market leader in kidney dialysis systems (KDSs). The company is looking at setting up a manufacturing plant overseas to produce a new line of KDSs. This will be a five year project.

The company bought some land three years ago for \$6 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. If the land were sold today, the net proceeds would be \$6.4 million after taxes. The company wants to build its new manufacturing plant on this land; the plant will cost \$9.8 million to build. The following market data on Mayo's securities are current:

Debt: 25,000 6.5 percent coupon bonds outstanding, 20 years to maturity, selling for 96 percent of par: the bonds have a \$1,000 par value each and make semiannual payments

Common Stock: 400,000 share outstanding, selling for \$89 per share; the beta is 1.20

Preferred Stock: 35,000 shares of 6.5 percent preferred stock outstanding, selling for \$99 per share

Market: 8 percent market risk premium; 5.20 percent risk-free rate

Mayo's tax rate is 34 percent. The project requires \$825,000 in initial net working capital investment to get operationa1.

The manufacturing plant has an eight-year life, and Mayo uses straight-line depreciation. At the end of the project (i.e., the end of year 5), the plant can be scrapped for \$1.25 million.

The company will incur \$2,100,000 in annual fixed costs. The plan is to manufacture 11,000 KDSs per year and sell them at \$10,000 per machine, the variable production costs are \$9,300 per KDS.

Mayo's president wants you to throw all your calculations, all your assumptions, and everything else into a report for the chief financial officer: all she wants to know is what the KDS project's NPV is.

Solution Summary

The solution explains how to calculate the cash flows, WACC and determine the NPV for the project

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