You are a manager at Northern Fibre, which is considering expanding its operations in synthetic fibre manufacturing. Your boss comes into your office, drops a consultant's report on your desk, and complains, "We owe these consultants $1.4 million for this report, and I am not sure their analysis makes sense. Before we spend the $27 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): 1 2 Sales revenue 27.000 27.000 9 27.000 10 27.000 - Cost of goods sold 16.200 16.200 16.200 16.200 = Gross profit 10.800 10.800 10.800 10.800 - General, sales, and administrative expenses - Depreciation 2.160 2.160 2.160 2.160 2.700 2.700 2.700 2.700 Net operating income 5.940 5.940 5.940 5.940 - Income tax 2.079 2.079 2.079 2.079 = Net income 3.861 3.861 3.861 3.861 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. CRA allows a CCA rate of 30% on the equipment for tax purposes. The report concludes that because the project will increase earnings by $3.861 million per year for 10 years, the project is worth $38.61 million. You think back to your glory 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 $9 million in working capital up front (year 0), which will be fully recovered in year 10. Next you see they have attributed $2.16 million of selling, general and administrative expenses to the project, but you know that $1.08 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 Fibre, which is considering expanding its operations in synthetic fibre manufacturing. Your boss comes into your office, drops a consultant's report on your desk, and complains, "We owe these consultants $1.4 million for this report, and I am not sure their analysis makes sense. Before we spend the $27 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): 1 2 Sales revenue 27.000 27.000 9 27.000 10 27.000 - Cost of goods sold 16.200 16.200 16.200 16.200 = Gross profit 10.800 10.800 10.800 10.800 - General, sales, and administrative expenses - Depreciation 2.160 2.160 2.160 2.160 2.700 2.700 2.700 2.700 Net operating income 5.940 5.940 5.940 5.940 - Income tax 2.079 2.079 2.079 2.079 = Net income 3.861 3.861 3.861 3.861 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. CRA allows a CCA rate of 30% on the equipment for tax purposes. The report concludes that because the project will increase earnings by $3.861 million per year for 10 years, the project is worth $38.61 million. You think back to your glory 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 $9 million in working capital up front (year 0), which will be fully recovered in year 10. Next you see they have attributed $2.16 million of selling, general and administrative expenses to the project, but you know that $1.08 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?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:You are a manager at Northern Fibre, which is considering expanding its operations in synthetic fibre manufacturing. Your boss comes into your office, drops a consultant's
report on your desk, and complains, "We owe these consultants $1.4 million for this report, and I am not sure their analysis makes sense. Before we spend the $27 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):
1
2
Sales revenue
27.000
27.000
9
27.000
10
27.000
- Cost of goods sold
16.200 16.200
16.200
16.200
= Gross profit
10.800 10.800
10.800
10.800
- General, sales, and administrative expenses
- Depreciation
2.160
2.160
2.160
2.160
2.700
2.700
2.700
2.700
Net operating income
5.940
5.940
5.940
5.940
- Income tax
2.079
2.079
2.079
2.079
= Net income
3.861
3.861
3.861
3.861
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. CRA allows a CCA rate of 30% on the equipment for tax purposes. The report concludes
that because the project will increase earnings by $3.861 million per year for 10 years, the project is worth $38.61 million. You think back to your glory 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 $9 million in working capital up front (year 0), which will be fully recovered in year 10.
Next you see they have attributed $2.16 million of selling, general and administrative expenses to the project, but you know that $1.08 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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