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 $1.9 million for this report, and I am not sure their analysis makes sense. Before we spend the $28 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 9 10 27.000 Sales revenue - Cost of goods sold 27.000 16.200 10.800 27.000 16.200 27.000 16.200 16.200 =Gross profit 10.800 10.800 10.800 - General, sales, and administrative expenses 2.240 2.240 2.240 2.240 -Depreciation 2.800 2.800 2.800 2.800 = Net operating income 5.7600 5.7600 -Income tax 5.7600 5.7600 2.016 3.744 2.016 2.016 2.016 = Net income 3.744 3.744 3.744 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 45% on the equipment for tax purposes. The report concludes that because the project will increase earnings by $3.744 million per year for ten years, the project is worth $37.44 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 $10 million in working capital up front (year 0), which will be fully recovered in year 10. Next you see they have attributed $2.24 million of selling, general and administrative expenses to the project, but you know that $1.12 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! b. If the cost of capital for this project is 10%, what is your estimate of the value of the new project? b. If the cost of capital for this project is 10%, what is your estimate of the value of the new project? Value of project = $ million (Round to three decimal places.)
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 $1.9 million for this report, and I am not sure their analysis makes sense. Before we spend the $28 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 9 10 27.000 Sales revenue - Cost of goods sold 27.000 16.200 10.800 27.000 16.200 27.000 16.200 16.200 =Gross profit 10.800 10.800 10.800 - General, sales, and administrative expenses 2.240 2.240 2.240 2.240 -Depreciation 2.800 2.800 2.800 2.800 = Net operating income 5.7600 5.7600 -Income tax 5.7600 5.7600 2.016 3.744 2.016 2.016 2.016 = Net income 3.744 3.744 3.744 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 45% on the equipment for tax purposes. The report concludes that because the project will increase earnings by $3.744 million per year for ten years, the project is worth $37.44 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 $10 million in working capital up front (year 0), which will be fully recovered in year 10. Next you see they have attributed $2.24 million of selling, general and administrative expenses to the project, but you know that $1.12 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! b. If the cost of capital for this project is 10%, what is your estimate of the value of the new project? b. If the cost of capital for this project is 10%, what is your estimate of the value of the new project? Value of project = $ million (Round to three decimal places.)
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 $1.9 million for this report, and I am not sure their
analysis makes sense. Before we spend the $28 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):
2
9
10
Sales revenue
1
27.000 27.000
16.200 16.200
10.800 10.800
2.240
- Cost of goods sold
27.000
16.200
10.800
27.000
16.200
= Gross profit
10.800
- General, sales, and administrative expenses
2.240
2.240
2.240
- Depreciation
2.800
2.800
2.800
2.800
5.7600
= Net operating income
5.7600
5.7600
5.7600
- Income tax
2.016
2.016
2.016
2.016
= Net income
3.744
3.744
3.744
3.744
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 45%
on the equipment for tax purposes. The report concludes that because the project will increase earnings by $3.744 million per year for ten years, the project is worth $37.44 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 $10 million in working capital up front (year 0), which will be fully recovered in year 10. Next you see they have attributed $2.24 million of selling, general and administrative expenses to the project, but
you know that $1.12 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!
b. If the cost of capital for this project is 10%, what is your estimate of the value of the new project?
b. If the cost of capital for this project is 10%, what is your estimate of the value of the new project?
Value of project = $
million (Round to three decimal places.)
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