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 $ 1.8 million for this​ report, and I am not sure their analysis makes sense. Before we spend the $ 20 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 following icon in order to copy its contents into a​ spreadsheet.) Project Year Earnings Forecast​ ($ million) 1 2 . . . 9 10 Sales revenue 31.000 31.000 31.000 31.000 minusCost of goods sold 18.600 18.600 18.600 18.600 equalsGross profit 12.400 12.400 12.400 12.400 minus​Selling, ​general, and administrative expenses 1.600 1.600 1.600 1.600 minusDepreciation 2.000 2.000 2.000 2.000 equalsNet operating income 8.800 8.800 8.800 8.800 minusIncome tax 1.76 1.76 1.76 1.76 equalsNet unlevered income 7.040 7.040 7.040 7.040 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 $ 7.040 million per year for ten​ years, the project is worth $ 70.4 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 $ 15 million in working capital upfront​ (year 0), which will be fully recovered in year 10.​ Next, you see they have attributed $ 1.6 million of​ selling, general and administrative expenses to the​ project, but you know that $ 0.8 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 11 %​, what is your estimate of the value of the new​ project?

Answer 1

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W ? v . 1* 01:28 ENG 19-02-2070 24 fix GW GX GYI GZ HA HB HC HD HE HE HG - HE440 X GU GV 420 421 422 FCF CALCULATIONS 0 10 423 1109 7.04 0.64 424 7.04 0.64 [=(1.6*50% *(1-0.2))] ADD ADD A25 FCF CALCULATIONS YEARS --- NET INCOME OVERHEAD (AFTER TAX @20%) DEPRECIATION INVESTMENT IN FIXED ASSETS INCREASE IN WORKING CAPITAL RECOVERY WORKING CAPITAL FREE CASH FLOW (FCF) NOTE TAX RATE INCOME TAX/OPERATING INCOME 1.76/8.8 = 20% [SEE GIVEN STATEMENT] 426 427 -20.000 -15.000 428 15.000 24.68 -35.000 9.68 429 430 431 432 433 FCF FOR YEAR 0 = FCF FOR YEAR 1 TO 9 = FCF FOR YEAR 10 = -35.000 9.68 24.68 -35.000 (round to 3 decimals] 9.680 [round to 3 decimals] 24.680 [round to 3 decimals] 434 note PVIFA @11%, 9 YEARS PVIF @11%, 10 YEARS 5.537048 0.352184 b NPV = 435 436 437 438 439 PV OF ALL CFAT - INVESTMENT (9.68 X PVIFA@11%, 9 YEARS) + (24.68 X PVIF@11%,10 YEARS) - 35.000 (9.68 X 5.537048 ) + (24.68 X 0.352184) - 35.000 27.291 MILLION VALUE = 440 YES, YOU SHOULD ACCCEPT THE PROJECT AS VALUE IS POSITIVE 441 442 443 ... deberk MARGIN MONEY marginal tax PB ROPI APV ROSS price quote EVA MVA LEVERAGED BUY SWAP Sheet2 distress BRIGHAN CAP ... :