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 $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): Sales revenue -Cost of goods sold Gross profit - General, sales, and administrative expenses Depreciation Net operating incomo -Income tax Net income Show Transcribed Text 3 1 2 30.000 30.000 18.000 18.000 12.000 12.000 1.840 1.840 2.300 2.300 7.8600 7.8600 2.751 2.751 5.109 5.109 *** 9 30.000 18.000 12.000 1.840 2.300 7.8600 2.751 5.109 10 30.000 18.000 12.000 1.840 2.300 7.8600 2.751 5.109 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 O), which is what the accounting department recommended for financial reporting purposes. CRA allows a CCA rate of 20% on the equipment for tax purposes. The report concludes that because the project will increase earnings by $5.109 million per year for ten years, the project is worth $51.09 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 $13 million in working capital up front (year O), 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!
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 $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): Sales revenue -Cost of goods sold Gross profit - General, sales, and administrative expenses Depreciation Net operating incomo -Income tax Net income Show Transcribed Text 3 1 2 30.000 30.000 18.000 18.000 12.000 12.000 1.840 1.840 2.300 2.300 7.8600 7.8600 2.751 2.751 5.109 5.109 *** 9 30.000 18.000 12.000 1.840 2.300 7.8600 2.751 5.109 10 30.000 18.000 12.000 1.840 2.300 7.8600 2.751 5.109 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 O), which is what the accounting department recommended for financial reporting purposes. CRA allows a CCA rate of 20% on the equipment for tax purposes. The report concludes that because the project will increase earnings by $5.109 million per year for ten years, the project is worth $51.09 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 $13 million in working capital up front (year O), 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!
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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 $1.1 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):
Sales revenue
-Cost of goods sold
= Gross profit
- General, sales, and administrative expenses
- Depreciation
= Net operating income
-Income tax
= Net income
Show Transcribed Text
O
C
3
1
2
30.000 30.000
18.000 18.000
12.000 12.000
1.840 1.840
2.300 2.300
7.8600 7.8600
2.751
2.751
5.109
5.109
...
9
30.000
18.000
12.000
1.840
2.300
7.8600
2.751
5.109
10
30.000
18.000
12.000
1.840
2.300
7.8600
2.751
5.109
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 20% on the equipment for tax purposes. The report concludes that because the project will increase earnings by $5.109 million per year for ten years, the project is worth $51.09
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 $13 million in working capital up front (year o), 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!
b. 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 to three decimal places.)
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