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 $1.2 million for this report, sure their analysis makes sense. Before we spend the $19 million on new equipment needed for this project, look it over and give me your opinion." You open the report and find the following estimates (in millions of dollars): (Click on the following icon in order t contents into a spreadsheet.) Earnings Forecast ($ million) 1 32.000 19.200 12.800 1.520 1.900 9.380 1.876 7.504 Sales revenue -Cost of goods sold -Gross profit - Selling, general, and administrative expenses Depreciation -Net operating income -Income tax -Net unlevered income Project Year 2 32.000 19.200 12.800 1.520 1.900 9.380 1.876 7.504 9 32.000 19.200 12.800 1.520 1.900 9.380 1.876 7.504 10 32.000 19.200 12.800 1.520 1.900 9.380 1.876 7.504 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 increase earnings by $7.504 million per year for ten years, the project is worth $75.04 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 $7 million in working capital upfront (year 0), which will be fully recovered in year 10. Next, you see they have attributed $1.52 million of selling, general and administrative ex the project, but you know that $0.76 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 11%, 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 $1.2 million for this report, sure their analysis makes sense. Before we spend the $19 million on new equipment needed for this project, look it over and give me your opinion." You open the report and find the following estimates (in millions of dollars): (Click on the following icon in order t contents into a spreadsheet.) Earnings Forecast ($ million) 1 32.000 19.200 12.800 1.520 1.900 9.380 1.876 7.504 Sales revenue -Cost of goods sold -Gross profit - Selling, general, and administrative expenses Depreciation -Net operating income -Income tax -Net unlevered income Project Year 2 32.000 19.200 12.800 1.520 1.900 9.380 1.876 7.504 9 32.000 19.200 12.800 1.520 1.900 9.380 1.876 7.504 10 32.000 19.200 12.800 1.520 1.900 9.380 1.876 7.504 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 increase earnings by $7.504 million per year for ten years, the project is worth $75.04 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 $7 million in working capital upfront (year 0), which will be fully recovered in year 10. Next, you see they have attributed $1.52 million of selling, general and administrative ex the project, but you know that $0.76 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 11%, what is your estimate of the value of the new project?
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
Related questions
Question
Please show how
![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 $1.2 million for this report, and I am not
sure their analysis makes sense. Before we spend the $19 million on new equipment needed for this project, look it over and give me your opinion." You open the report and find the following estimates (in millions of dollars): (Click on the following icon in order to copy its
contents into a spreadsheet.)
Sales revenue
- Cost of goods sold
= Gross profit
Earnings Forecast ($ million)
1
32.000
19.200
12.800
1.520
1.900
9.380
1.876
7.504
- Selling, general, and administrative expenses
- Depreciation
= Net operating income
- Income tax
= Net unlevered income
Project Year
2
32.000
19.200
12.800
1.520
1.900
9.380
1.876
7.504
9
32.000
19.200
12.800
1.520
1.900
9.380
1.876
7.504
10
32.000
19.200
12.800
1.520
1.900
9.380
1.876
7.504
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 $7.504 million per year for ten years, the project is worth $75.04 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 $7 million in working capital upfront (year 0), which will be fully recovered in year 10. Next, you see they have attributed $1.52 million of selling, general and administrative expenses to
the project, but you know that $0.76 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 11%, what is your estimate of the value of the new project?
C
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?
The free cash flow for year 0 is $ - 26.000 million. (Round to three decimal places and enter a decrease as a negative number.)
The free cash flow for years 1 to 9 is $ 10.012 million. (Round to three decimal places and enter a decrease as a negative number.)
The free cash flow for year 10 is $ 17.012 million. (Round to three decimal places and enter a decrease as a negative number.)
b. If the cost of capital for this project is 11%, what is your estimate of the value of the new project?
The value of the project is $ 35.428 million. (Round to three decimal places.)](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F37090eef-025f-4619-bebd-91b936ece1eb%2F968a0475-9f78-403d-97b2-25a61088f64b%2Fhcpntij_processed.png&w=3840&q=75)
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 $1.2 million for this report, and I am not
sure their analysis makes sense. Before we spend the $19 million on new equipment needed for this project, look it over and give me your opinion." You open the report and find the following estimates (in millions of dollars): (Click on the following icon in order to copy its
contents into a spreadsheet.)
Sales revenue
- Cost of goods sold
= Gross profit
Earnings Forecast ($ million)
1
32.000
19.200
12.800
1.520
1.900
9.380
1.876
7.504
- Selling, general, and administrative expenses
- Depreciation
= Net operating income
- Income tax
= Net unlevered income
Project Year
2
32.000
19.200
12.800
1.520
1.900
9.380
1.876
7.504
9
32.000
19.200
12.800
1.520
1.900
9.380
1.876
7.504
10
32.000
19.200
12.800
1.520
1.900
9.380
1.876
7.504
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 $7.504 million per year for ten years, the project is worth $75.04 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 $7 million in working capital upfront (year 0), which will be fully recovered in year 10. Next, you see they have attributed $1.52 million of selling, general and administrative expenses to
the project, but you know that $0.76 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 11%, what is your estimate of the value of the new project?
C
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?
The free cash flow for year 0 is $ - 26.000 million. (Round to three decimal places and enter a decrease as a negative number.)
The free cash flow for years 1 to 9 is $ 10.012 million. (Round to three decimal places and enter a decrease as a negative number.)
The free cash flow for year 10 is $ 17.012 million. (Round to three decimal places and enter a decrease as a negative number.)
b. If the cost of capital for this project is 11%, what is your estimate of the value of the new project?
The value of the project is $ 35.428 million. (Round to three decimal places.)
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