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 $1.6 million for this report, and I am not sure their analysis makes sense. Before we spend the $16 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 2 1 35.000 35.000 21.000 21.000 14.000 14.000 1.280 1.280 1.600 1.600 11.1200 11.1200 3.892 3.892 7.228 7.228 10 9 35.000 35.000 21.000 21.000 14.000 14.000 1.280 1.280 1.600 1.600 11.1200 11.1200 3.892 3.892 7.228 7.228 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 $7.228 million per year for ten years, the project is worth $72.28 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 $10 million in working capital up front (year 0), which will be fully recovered in year 10. Next you see they have attributed $1.28 million of selling, general and administrative expenses to the project, but you know that $0.64 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 16%, what is your estimate of the value of the new project? b. If the cost of capital for this project is 16%, what is your estimate of the value of the new project? Value of project = $ million (Round to three decimal places.) C

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
icon
Related questions
Question
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
$1.6 million for this report, and I am not sure their analysis makes sense. Before we spend the $16 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
2
35.000 35.000
21.000 21.000
14.000 14.000
1.280 1.280
1.600
1.600
11.1200 11.1200
3.892 3.892
7.228
7.228
9
35.000
21.000
14.000
1.280
1.600
11.1200
3.892
7.228
10
35.000
21.000
14.000
1.280
1.600
11.1200
3.892
7.228
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 $7.228 million per year for ten years, the project is worth $72.28 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 $10 million in working capital up front (year 0), which will be fully recovered in year 10. Next you see they have attributed $1.28 million of selling,
general and administrative expenses to the project, but you know that $0.64 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 16%, what is your estimate of the value of the new project?
b. If the cost of capital for this project is 16%, what is your estimate of the value of the new project?
Value of project = $
million (Round to three decimal places.)
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 $1.6 million for this report, and I am not sure their analysis makes sense. Before we spend the $16 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 2 35.000 35.000 21.000 21.000 14.000 14.000 1.280 1.280 1.600 1.600 11.1200 11.1200 3.892 3.892 7.228 7.228 9 35.000 21.000 14.000 1.280 1.600 11.1200 3.892 7.228 10 35.000 21.000 14.000 1.280 1.600 11.1200 3.892 7.228 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 $7.228 million per year for ten years, the project is worth $72.28 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 $10 million in working capital up front (year 0), which will be fully recovered in year 10. Next you see they have attributed $1.28 million of selling, general and administrative expenses to the project, but you know that $0.64 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 16%, what is your estimate of the value of the new project? b. If the cost of capital for this project is 16%, what is your estimate of the value of the new project? Value of project = $ million (Round to three decimal places.)
Expert Solution
trending now

Trending now

This is a popular solution!

steps

Step by step

Solved in 3 steps with 2 images

Blurred answer
Knowledge Booster
Valuing Decision
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.
Similar questions
  • SEE MORE QUESTIONS
Recommended textbooks for you
Essentials Of Investments
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
FUNDAMENTALS OF CORPORATE FINANCE
FUNDAMENTALS OF CORPORATE FINANCE
Finance
ISBN:
9781260013962
Author:
BREALEY
Publisher:
RENT MCG
Financial Management: Theory & Practice
Financial Management: Theory & Practice
Finance
ISBN:
9781337909730
Author:
Brigham
Publisher:
Cengage
Foundations Of Finance
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education