Reference no: EM132847893
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 $1.1 million for this? report, and I am not sure their analysis makes sense. Before we spend the $25 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
Sales revenue 34.000 34.000 34.000 34.000
-Cost of goods sold 20.400 20.400 20.400 20.400
=Gross profit 13.600 13.600 13.600 13.600
-?General, ?sales, and administrative expenses 2.000 2.000 2.000 2.000
-Depreciation 2.500 2.500 2.500 2.500
=Net operating income 9.100 9.100 9.100 9.100
-Income tax 3.185 3.185 3.185 3.185
=Net income 5.915 5.915 5.915 5.915
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 $5.915 million per year for 10? years, the project is worth $59.15 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 $9 million in working capital up front? (year 0), which will be fully recovered in year 10. Next you see they have attributed $2 million of? selling, general and administrative expenses to the? project, but you know that $1 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?