50.1K

Verified Solution

Link Copied!

Right click and "open image in new tab" for better resolution

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 $1.8 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):

	1	2	. . .	9	10
Sales revenue	26.000	26.000		26.000	26.000
Cost of goods sold	15.600	15.600		15.600	15.600
=Gross profit	10.400	10.400		10.400	10.400
General, sales, and administrative expenses	1.520	1.520		1.520	1.520
Depreciation	1.900	1.900		1.900	1.900
=Net operating income	6.980	6.980		6.980	6.980
Income tax	2.443	2.443		2.443	2.443
=Net income	4.537	4.537		4.537	4.537

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 $4.537 million per year for 10 years, the project is worth $45.37 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 $8 million in working capital up front (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?

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 $1.8 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): Sales revenue - Cost of goods sold = Gross profit - General, sales, and administrative expenses - Depreciation = Net operating income - Income tax = Net income 1 26.000 15.600 10.400 1.520 1.900 6.980 2.443 4.537 2 26.000 15.600 10.400 1.520 1.900 6.980 2.443 4.537 9 26.000 15.600 10.400 1.520 1.900 6.980 2.443 4.537 10 26.000 15.600 10.400 1.520 1.900 6.980 2.443 4.537 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 $4.537 million per year for 10 years, the project is worth $45.37 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 58 million in working capital up front (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

Answer & Explanation Solved by verified expert

See Answer