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 million for this report, and I am not sure their analysis makes sense. Before we spend the $25 million on the new equipment needed for this project, look it over and give me your opinion." You open the report and find the following estimates (in thousands of dollars) for the project:       Project year       1 2 … 9 10 Sales revenue 30,000 30,000   30,000 30,000 - Cost of goods sold 18,000 18,000   18,000 18,000 =Gross profit 12,000 12,000   12,000 12,000 - Gen, sales and admin expenses 2,000 2,000   2,000 2,000 - Depreciation 2,500 2,500   2,500 2,500 =Net operating income 7,500 7,500   7,500 7,500 - Income tax 2,625 2,625   2,625 2,625 =Net Income 4,875 4,875   4,875 4,875 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. The report concludes that because the project will increase earnings by $4.875 million per year for ten years, the project is worth $48.75 million. You think back to your halcyon 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 upfront (year 0), which will be fully recovered in year 10. Next, you see they have attributed $2 million of selling, general and administrative expenses to the project but you know that $1 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! for solving the following problems, please don't use excel  Given the available information, what are the free cash flows in years 0 through 10 that should be used to evaluate the proposed project? If the cost of capital for this project is 14%, what is your estimate of the value of the new project?

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 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 million for this report, and I am not sure their analysis makes sense. Before we spend the $25 million on the new equipment needed for this project, look it over and give me your opinion." You open the report and find the following estimates (in thousands of dollars) for the project:

     

Project year

   
 

1

2

9

10

Sales revenue

30,000

30,000

 

30,000

30,000

- Cost of goods sold

18,000

18,000

 

18,000

18,000

=Gross profit

12,000

12,000

 

12,000

12,000

- Gen, sales and admin expenses

2,000

2,000

 

2,000

2,000

- Depreciation

2,500

2,500

 

2,500

2,500

=Net operating income

7,500

7,500

 

7,500

7,500

- Income tax

2,625

2,625

 

2,625

2,625

=Net Income

4,875

4,875

 

4,875

4,875

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. The report concludes that because the project will increase earnings by $4.875 million per year for ten years, the project is worth $48.75 million. You think back to your halcyon 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 upfront (year 0), which will be fully recovered in year 10. Next, you see they have attributed $2 million of selling, general and administrative expenses to the project but you know that $1 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!

for solving the following problems, please don't use excel 

  1. Given the available information, what are the free cash flows in years 0 through 10 that should be used to evaluate the proposed project?
  2. If the cost of capital for this project is 14%, what is your estimate of the value of the new project? 
Expert Solution
trending now

Trending now

This is a popular solution!

steps

Step by step

Solved in 2 steps

Blurred answer
Knowledge Booster
Theory of Constraints (TOC)
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