Question

PLEASE BE 100% CORRECT BEFORE ANSWERING, AND ILL LEAVE A THUMBS UP!

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 $23 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 16.200 Sales revenue - Cost of goods sold = Gross profit - General, sales, and administrative expenses - Depreciation = Net operating income - Income tax = Net income 27.000 16.200 10.800 1.840 2.300 6.6600 2.331 4.329 10.800 1.840 2.300 6.6600 2.331 4.329 27.000 16.200 10.800 1.840 2.300 6.6600 2.331 4.329 27.000 16.200 10.800 1.840 2.300 6.6600 2.331 4.329

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 $4.329 million per year for ten​ years, the project is worth $43.29 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 $11 million in working capital up front​ (year 0), which will be fully recovered in year 10. Next you see they have attributed $1.84 million of​ selling, general and administrative expenses to the​ project, but you know that $0.92 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!

QUESTION

If the cost of capital for this project is 15%​, what is your estimate of the value of the new​ project?

Value of Project= $ ______ million (Round your answer to three decimal places.)

Answer 1

Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year o Year 1 -23 -11 27 27 27 27 27 27 27 27 -16.200 -16.200 -16.200 10.800 -1.840 -16.200 10.800 27 -16.200 10.800 -16.200 10.800 10.800 -1.840 27 -16.200 10.800 -1.840 -16.200 10.800 -1.840 0.920 -2.300 -16.200 10.800 -1.840 0.920 10.800 -1.840 0.920 -1.840 Answer: Particulars Cost of Machine Change in Net working Capital Sales Revenue Less: Cost of Goods Sold Gross Profit Less: Gen Nad Admin Expenses Overhead incuured anyway Less: Depreciation Net Operating Income Less: Income tax @ 35% Net Income Add: Depreciation Free Cash Flow Working Capital recovery Cash Flow -16.200 10.800 -1.840 0.920 -1.840 -1.840 0.920 0.920 0.920 0.920 0.920 -2.300 0.920 -2.300 -2.300 -2.300 -2.300 -2.300 -2.300 -2.300 7.580 7.580 7.580 7.580 -2.300 7.5801 -2.653 4.9271 2.300 7.580 -2.653 7.580 -2.653 7.580 -2.653 7.580 -2.653 -2.653 4.927 2.300 4.927 2.300 -2.653 4.9271 2.300 7.227 4.9271 2.300 7.227 4.9271 2.300 7.227 -2.653 4.927 2.300 7.227 7.580 -2.653 4.927 2.300 7.227 -2.653 4.927 2.300 7.227 7.227 7.227 7.227 4.927 2.300 7.227 11.000 18.2271 -34 7.227 7.227 7.227 7.227 7.227 7.227 7.227 7.227 7.227 Value of Project Year 1-9 Cash Flow PVF @159 Present Value 7.2271 4.7716 34.484 18.227 0.2472 4.506 10 38.990 -34 Less: Initial Cost value of Projects Value of Project = $4.990 million 4.990 Note: Tax Rate = 2.331 /6.6600 = 35%