Question

You are a manager at Percolated​ 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 $19 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):

... Earnings Forecast ($ million) Sales revenue - Cost of goods sold = Gross profit - Selling, general, and administrative expenses - Depreciation = Net operating income - Income tax = Net unlevered income 1 29.000 17.400 11.600 1.520 1.900 8.180 2.863 5.317 Project Year 2 29.000 17.400 11.600 1.520 1.900 8.180 2.863 5.317 9 29.000 17.400 11.600 1.520 1.900 8.180 2.863 5.317 10 29.000 17.400 11.600 1.520 1.900 8.180 2.863 5.317

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. The report concludes that because the project will increase earnings by $5.317 million per year for ten​ years, the project is worth $53.17 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 $9 million in working capital upfront​ (year 0), which will be fully recovered in year 10.​ Next, you see they have attributed $1.52 million of​ selling, general and administrative expenses to the​ project, but you know that $0.76 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?

b. If the cost of capital for this project is 12%​, what is your estimate of the value of the new​ project?

Answer 1

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

- 2x HG 399 400 404 PE EPS, STOCK DIVIDEND - Microsoft Excel (Product Activation Failed) File Home Insert Page Layout Formulas Data Review View Add-Ins % Cut Σ AutoSum : A Calibri 11 AA = = = Dr Wrap Text General E Copy Fill Paste B Format Painter I - U D A Sort & Merge & Center Find & $ - % 8. Formatting as Table Styles 2 Clear Filter Select Clipboard Font Alignment Number Styles Cells Editing HF398 GU GV GW GX GY G Z HA HB HC HD HE HE 398 FCF CALCULATIONS YEARS ------------------> 0 1 TO 9 10 NET INCOME 5.317 5.317 ADD OVERHEAD (AFTER TAX @35%) 0.494 0.494 [=(0.76*(1-0.35))] 401 ADD DEPRECIATION 1.9 1.9 402 INVESTMENT IN FIXED ASSETS -19.000 403 INCREASE IN WORKING CAPITAL -9.000 RECOVERY WORKING CAPITAL 9.000 405 FREE CASH FLOW (FCF) -28.000 7.7110 16.7110 406 407 FCE FOR YEAR O= -28.000 408 FCE FOR YEAR 1 TO 9 = 7.711 note 409 FCE FOR YEAR 10 = 16.711 EXCEL 410 PVIFA @12%, 9 YEARS 5.328250 411 NPV = PV OF ALL CFAT - INVESTMENT PVIF @12%, 10 YEARS 0.321973 412 (7.7110 X PVIFA@12%, 9 YEARS) + (16.7110 X PVIF@12%, 10 YEARS) - 28 413 (7.7110 X 5.328250) +(16.7110 X 0.321973) - 28 VALUE = 18.467 MILLION 415 416 YES, YOU SHOULD ACCCEPT THE PROJECT AS VALUE IS POSITIVE H HIGH LOW TARGET PRICE STOCK DIV NAV HEDGE FUND ME EV PE EPS DIV ABNORMAL deberk MARGIN MONEY marginal tax PB ROPI APV ROSS price quote EVA MVAI Rea ferences 0 130% D E O * 10 ENG 414 0 + 29-11-2019