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You are a manager at Percolated Fiber, which is considering expanding its operations in synthetic fiber manufacturing. Your boss comes into your office, drops a consultant's report on your desk, and complains, "We owe these consultants $1.500 million for this report, and I am not sure their analysis makes sense. Before we spend the $27.700 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): 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. They also calculated the depreciation assuming no salvage value for the equipment. The report concludes that because the project will increase earnings by $6.805 million per year for 10 years, the project is worth $68.050 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 included the fact that the project will require $11.700 million in working capital up front (year 0), which will be fully recovered in year 10. Next, you see they have attributed $2.216 million of selling, general, and administrative expenses to the project, but you know that $1.108 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? b. If the cost of capital for this project is 13%, what is your estimate of the value of the new project?

You are a manager at Percolated Fiber, which is considering expanding its operations in synthetic fiber manufacturing. Your boss comes into your office, drops a consultant's report on your desk, and complains, "We owe these consultants $1.500 million for this report, and I am not sure their analysis makes sense. Before we spend the $27.700 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): 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. They also calculated the depreciation assuming no salvage value for the equipment. The report concludes that because the project will increase earnings by $6.805 million per year for 10 years, the project is worth $68.050 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 included the fact that the project will require $11.700 million in working capital up front (year 0), which will be fully recovered in year 10. Next, you see they have attributed $2.216 million of selling, general, and administrative expenses to the project, but you know that $1.108 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? b. If the cost of capital for this project is 13%, what is your estimate of the value of the new project?

Managerial Accounting: The Cornerstone of Business Decision-Making
Managerial Accounting: The Cornerstone of Business Decision-Making
7th Edition
ISBN:9781337115773
Author:Maryanne M. Mowen, Don R. Hansen, Dan L. Heitger
Publisher:Maryanne M. Mowen, Don R. Hansen, Dan L. Heitger
Chapter5: Activity-based Costing And Management
Section: Chapter Questions
Problem 64C: Consider the following conversation between Leonard Bryner, president and manager of a firm engaged...
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You are a manager at Percolated Fiber, which is considering expanding its operations in synthetic fiber manufacturing. Your boss comes into your office, drops a consultant's report on your desk, and complains, "We owe these consultants $1.500 million for this report, and I am not sure their analysis makes sense. Before we spend the $27.700 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): 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. They also calculated the depreciation assuming no salvage value for the equipment. The report concludes that because the project will increase earnings by $6.805 million per year for 10 years, the project is worth $68.050 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 included the fact that the project will require $11.700 million in working capital up front (year 0), which will be fully recovered in year 10. Next, you see they have attributed $2.216 million of selling, general, and administrative expenses to the project, but you know that $1.108 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? b. If the cost of capital for this project is 13%, what is your estimate of the value of the new project?
Transcribed Image Text:You are a manager at Percolated Fiber, which is considering expanding its operations in synthetic fiber manufacturing. Your boss comes into your office, drops a consultant's report on your desk, and complains, "We owe these consultants $1.500 million for this report, and I am not sure their analysis makes sense. Before we spend the $27.700 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): 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. They also calculated the depreciation assuming no salvage value for the equipment. The report concludes that because the project will increase earnings by $6.805 million per year for 10 years, the project is worth $68.050 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 included the fact that the project will require $11.700 million in working capital up front (year 0), which will be fully recovered in year 10. Next, you see they have attributed $2.216 million of selling, general, and administrative expenses to the project, but you know that $1.108 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? b. If the cost of capital for this project is 13%, what is your estimate of the value of the new project?
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