You are a manager at Northern Fiber, which is considering expanding its operations in synthetic fiber manufacturing. Your boss comes into your office, drops a consultant's report on your desk, and complains, "We owe these consultants $1.5 million for this report, and I am not sure their analysis makes sense. Before we spend the $29 million on new equipment needed for this project, look it over and give me your opinion." You open the report and find the following estimates (in millions of dollars): (Click on the Icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.) Project Year Earnings Forecast ($000,000s) 1 2 . . . 9 10 Sales revenue 25.000 25.000 25.000 25.000 −Cost of goods sold 15.000 15.000 15.000 15.000 =Gross profit 10.000 10.000 10.000 10.000 −Selling, general, and administrative expenses 2.320 2.320 2.320 2.320 −Depreciation 2.900 2.900 2.900 2.900 =Net operating income 4.7800 4.7800 4.7800 4.7800 −Income tax 1.673 1.673 1.673 1.673 =Net income 3.107 3.107 3.107 3.107 All of the estimates in the report seem correct. You note that the consultants used straight-line depreciation for the new equipment that will be purchased today (year 0), which is what the accounting department recommended for financial reporting purposes. Canada Revenue Agency allows a CCA rate of 30% on the equipment for tax purposes. The report concludes that because the project will increase earnings by $3.107 million per year for ten years, the project is worth $31.07 million. You think back to your halcyon days in finance class and realize there is more work to be done! First, you note that the consultants have not factored in the fact that the project will require $14 million in working capital upfront (year 0), which will be fully recovered in year 10. Next, you see they have attributed $2.32 million of selling, general and administrative expenses to the project, but you know that $1.16 million of this amount is overhead that will be incurred even if the project is not accepted. Finally, you know that accounting earnings are not the right thing to focus on! a. Given the available information, what are the free cash flows in years 0 through 10 that should be used to evaluate the proposed project?

You are a manager at Northern Fiber, which is considering expanding its operations in synthetic fiber manufacturing. Your boss comes into your office, drops a consultant's report on your desk, and complains, "We owe these consultants $1.5 million for this report, and I am not sure their analysis makes sense. Before we spend the $29 million on new equipment needed for this project, look it over and give me your opinion." You open the report and find the following estimates (in millions of dollars): (Click on the Icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.) Project Year Earnings Forecast ($000,000s) 1 2 . . . 9 10 Sales revenue 25.000 25.000 25.000 25.000 −Cost of goods sold 15.000 15.000 15.000 15.000 =Gross profit 10.000 10.000 10.000 10.000 −Selling, general, and administrative expenses 2.320 2.320 2.320 2.320 −Depreciation 2.900 2.900 2.900 2.900 =Net operating income 4.7800 4.7800 4.7800 4.7800 −Income tax 1.673 1.673 1.673 1.673 =Net income 3.107 3.107 3.107 3.107 All of the estimates in the report seem correct. You note that the consultants used straight-line depreciation for the new equipment that will be purchased today (year 0), which is what the accounting department recommended for financial reporting purposes. Canada Revenue Agency allows a CCA rate of 30% on the equipment for tax purposes. The report concludes that because the project will increase earnings by $3.107 million per year for ten years, the project is worth $31.07 million. You think back to your halcyon days in finance class and realize there is more work to be done! First, you note that the consultants have not factored in the fact that the project will require $14 million in working capital upfront (year 0), which will be fully recovered in year 10. Next, you see they have attributed $2.32 million of selling, general and administrative expenses to the project, but you know that $1.16 million of this amount is overhead that will be incurred even if the project is not accepted. Finally, you know that accounting earnings are not the right thing to focus on! a. Given the available information, what are the free cash flows in years 0 through 10 that should be used to evaluate the proposed project?

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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Question

$1.5

million for this report, and I am not sure their analysis makes sense. Before we spend the

$29

million on new equipment needed for this project, look it over and give me your opinion." You open the report and find the following estimates (in millions of dollars):

(Click on the Icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.)

	Project Year
Earnings Forecast ($000,000s)	1	2	. . .	9	10
Sales revenue	25.000	25.000		25.000	25.000
−Cost of goods sold	15.000	15.000		15.000	15.000
=Gross profit	10.000	10.000		10.000	10.000
−Selling, general, and administrative expenses	2.320	2.320		2.320	2.320
−Depreciation	2.900	2.900		2.900	2.900
=Net operating income	4.7800	4.7800		4.7800	4.7800
−Income tax	1.673	1.673		1.673	1.673
=Net income	3.107	3.107		3.107	3.107

All of the estimates in the report seem correct. You note that the consultants used straight-line depreciation for the new equipment that will be purchased today (year 0), which is what the accounting department recommended for financial reporting purposes. Canada Revenue Agency allows a CCA rate of

30%

on the equipment for tax purposes. The report concludes that because the project will increase earnings by

$3.107

million per year for ten years, the project is worth

$31.07

million. You think back to your halcyon days in finance class and realize there is more work to be done!

First, you note that the consultants have not factored in the fact that the project will require

$14

million in working capital upfront (year 0), which will be fully recovered in year 10. Next, you see they have attributed

$2.32

million of selling, general and administrative expenses to the project, but you know that

$1.16

million of this amount is overhead that will be incurred even if the project is not accepted. Finally, you know that accounting earnings are not the right thing to focus on!

a. Given the available information, what are the free cash flows in years 0 through 10 that should be used to evaluate the proposed project?

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