You are a manager at Percolated? Fiber, which is considering expanding its operations in synthetic fiber...

70.2K

Verified Solution

Question

Finance

You are a manager at Percolated? Fiber, which is consideringexpanding its operations in synthetic fiber manufacturing. Yourboss comes into your? office, drops a? consultant's report on your?desk, and? complains, "We owe these consultants $ 1.9 million forthis? report, and I am not sure their analysis makes sense. Beforewe spend the $ 27 million on new equipment needed for this?project, look it over and give me your? opinion." You open thereport and find the following estimates? (in millions of? dollars):?(Click on the Icon located on the? top-right corner of the datatable below in order to copy its contents into a? spreadsheet.)
Project Year
Earnings Forecast? ($ million) 1 2 . . . . . 9 10
Sales revenue 28.000 28.000 28.000 28.000
- Cost of goods sold 16.800 16.800 16.800 16.800
= Gross profit 11.200 11.200 11.200 11.200
- Selling, ?general, 2.160 2.160 2.160 2.160
and administrative expenses
- Depreciation 2.700 2.700 2.700 2.700
= Net operating income 6.340 6.340 6.340 6.340
- Income tax 2.219 2.219 2.219 2.219
= Net unlevered income 4.121 4.121 4.121 4.121
All of the estimates in the report seem correct. You note thatthe consultants used? straight-line depreciation for the newequipment that will be purchased today? (year 0), which is what theaccounting department recommended. The report concludes thatbecause the project will increase earnings by $ 4.121 million peryear for ten? years, the project is worth $ 41.21 million. Youthink back to your halcyon days in finance class and realize thereis more work to be? done!?? ?First, you note that the consultantshave not factored in the fact that the project will require $ 15million in working capital upfront? (year 0), which will be fullyrecovered in year 10.? Next, you see they have attributed $ 2.16million of? selling, general and administrative expenses to the?project, but you know that $ 1.08 million of this amount isoverhead that will be incurred even if the project is notaccepted.? Finally, you know that accounting earnings are not theright thing to focus? on!
a. Given the available? information, what are the free cashflows in years 0 through 10 that should be used to evaluate theproposed? project?
b. If the cost of capital for this project is 14 %?, what isyour estimate of the value of the new? project?

Answer & Explanation Solved by verified expert

3.6 Ratings (420 Votes)

tax rate See Answer

Get Answers to Unlimited Questions

Join us to gain access to millions of questions and expert answers. Enjoy exclusive benefits tailored just for you!

Membership Benefits:

Unlimited Question Access with detailed Answers
Zin AI - 3 Million Words
10 Dall-E 3 Images
20 Plot Generations
Conversation with Dialogue Memory
No Ads, Ever!
Access to Our Best AI Platform: Flex AI - Your personal assistant for all your inquiries!

Become a Member

Transcribed Image Text

You are a manager at Percolated? Fiber, which is consideringexpanding its operations in synthetic fiber manufacturing. Yourboss comes into your? office, drops a? consultant's report on your?desk, and? complains, "We owe these consultants $ 1.9 million forthis? report, and I am not sure their analysis makes sense. Beforewe spend the $ 27 million on new equipment needed for this?project, look it over and give me your? opinion." You open thereport and find the following estimates? (in millions of? dollars):?(Click on the Icon located on the? top-right corner of the datatable below in order to copy its contents into a? spreadsheet.)Project YearEarnings Forecast? ($ million) 1 2 . . . . . 9 10Sales revenue 28.000 28.000 28.000 28.000- Cost of goods sold 16.800 16.800 16.800 16.800= Gross profit 11.200 11.200 11.200 11.200- Selling, ?general, 2.160 2.160 2.160 2.160and administrative expenses- Depreciation 2.700 2.700 2.700 2.700= Net operating income 6.340 6.340 6.340 6.340- Income tax 2.219 2.219 2.219 2.219= Net unlevered income 4.121 4.121 4.121 4.121All of the estimates in the report seem correct. You note thatthe consultants used? straight-line depreciation for the newequipment that will be purchased today? (year 0), which is what theaccounting department recommended. The report concludes thatbecause the project will increase earnings by $ 4.121 million peryear for ten? years, the project is worth $ 41.21 million. Youthink back to your halcyon days in finance class and realize thereis more work to be? done!?? ?First, you note that the consultantshave not factored in the fact that the project will require $ 15million in working capital upfront? (year 0), which will be fullyrecovered in year 10.? Next, you see they have attributed $ 2.16million of? selling, general and administrative expenses to the?project, but you know that $ 1.08 million of this amount isoverhead that will be incurred even if the project is notaccepted.? Finally, you know that accounting earnings are not theright thing to focus? on!a. Given the available? information, what are the free cashflows in years 0 through 10 that should be used to evaluate theproposed? project?b. If the cost of capital for this project is 14 %?, what isyour estimate of the value of the new? project?