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 $1.5 million for this report, and I am not sure their analysis makes sense. Before we spend the $28 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 Sales revenue 29.000 29.000 9 29.000 10 29.000 -Cost of goods sold 17.400 17.400 17.400 17.400 = Gross profit 11.600 11.600 11.600 11.600 - General, sales, and administrative expenses 2.240 2.240 2.240 2.240 - Depreciation 2.800 2.800 2.800 2.800 = Net operating income 6.5600 6.5600 6.5600 6.5600 - Income tax = Net income 2.296 4.264 2.296 2.296 2.296 4.264 4.264 4.264 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 $4.264 million per year for ten years, the project is worth $42.64 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 $2.24 million of selling, general and administrative expenses to the project, but you know that $1.12 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! b. If the cost of capital for this project is 11%, what is your estimate of the value of the new project? b. If the cost of capital for this project is 11%, what is your estimate of the value of the new project? Value of project = $ million (Round to three decimal places.)
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 $1.5 million for this report, and I am not sure their analysis makes sense. Before we spend the $28 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 Sales revenue 29.000 29.000 9 29.000 10 29.000 -Cost of goods sold 17.400 17.400 17.400 17.400 = Gross profit 11.600 11.600 11.600 11.600 - General, sales, and administrative expenses 2.240 2.240 2.240 2.240 - Depreciation 2.800 2.800 2.800 2.800 = Net operating income 6.5600 6.5600 6.5600 6.5600 - Income tax = Net income 2.296 4.264 2.296 2.296 2.296 4.264 4.264 4.264 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 $4.264 million per year for ten years, the project is worth $42.64 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 $2.24 million of selling, general and administrative expenses to the project, but you know that $1.12 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! b. If the cost of capital for this project is 11%, what is your estimate of the value of the new project? b. If the cost of capital for this project is 11%, what is your estimate of the value of the new project? Value of project = $ million (Round to three decimal places.)
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
Related questions
Question
Transcribed Image Text: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 $1.5 million for this report, and I
am not sure their analysis makes sense. Before we spend the $28 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
Sales revenue
29.000
29.000
9
29.000
10
29.000
-Cost of goods sold
17.400 17.400
17.400
17.400
= Gross profit
11.600 11.600
11.600 11.600
- General, sales, and administrative expenses
2.240 2.240
2.240
2.240
- Depreciation
2.800 2.800
2.800
2.800
= Net operating income
6.5600 6.5600
6.5600
6.5600
- Income tax
= Net income
2.296
4.264
2.296
2.296
2.296
4.264
4.264
4.264
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 $4.264
million per year for ten years, the project is worth $42.64 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 $2.24 million of selling, general and administrative
expenses to the project, but you know that $1.12 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!
b. If the cost of capital for this project is 11%, what is your estimate of the value of the new project?
b. If the cost of capital for this project is 11%, what is your estimate of the value of the new project?
Value of project = $ million (Round to three decimal places.)
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