QUESTION 2: WEIGHTED AVERAGE COST OF CAPITAL (22 Marks)Defence Electronics International (DEI) a large publicly listed company is the market leader in radar detection systems (RDSs). The company is looking to set up a manufacturing plant overseas to produce a new line of RDSs. This will be a five year project. The company bought a piece of land three years ago for $ 7 million in anticipation of using it as a toxic dump site for waste chemicals, but instead built a piping system to discard chemicals safely. If the company sold the land today it would receive $ 6.5 million after taxes. In five years the land can be sold for $4.5 million after taxes and reclamation costs. DEI wants to build a new manufacturing plant on this land. The plant will cost $15 million to build. The following market data on DEI’s securities are current:The following information is relevant:a. The manufacturing plant has a ten-year tax life and DEI uses straight line method of depreciation for the plant. At the end of the project, (i.e. at the end of year 5), the plant can be scrapped for $ 5 million.Page 4 of 64. The new RDS project is somewhat riskier than a typical project for DEI, primarily because the plant is being located overseas. Explain briefly how DEI could accommodate this additional risk factor in the determination of its discount factor?(2 MARKS)
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