What’s wrong with this picture? In the following discussion see how many errors you can spot and explain briefly why each is an error. You do not need to correct the error.

“Lian, I think we’ve got a winner here. Take a look at these numbers!”

thousands)
0 1 2 3 ... 10 Initial cost −1,000 Units sold 100 100 100 ... 100 Price/unit 15 15 15 ... 15 Total revenue 1,500 1,500 1,500 ... 1,500 Cost of goods sold 800 800 800 ... 800 Gross profit 700 700 700 ... 700 Operating expenses Depreciation 100 100 100 ... 100 Interest expense 100 100 100 ... 100 Income before tax 500 500 500 ... 500 Tax @ 40% 200 200 200 ... 200 Income after tax 300 300 300 . .. 3 0 0

“Now, Lian, here’s how I figure it: The boss says our corporate goal should be to increase earnings by at least 15 percent every year, and this project certainly increases earnings. It adds $300,000 to net income after tax every year. My trusty calculator tells me that the rate of return on this project is 30 percent ($300/$1,000), well above our minimum target return of 10 percent. And if you want to use net present value, its NPV discounted at 10 percent is $843.50. So, what do you think, Lian?”
“Well, David, it looks pretty good, but I do have a few questions.”
“Shoot, Lian.”
“OK. What about increases in accounts receivable and stuff like that?”
“Not relevant! We’ll get that money back when the project terminates, so it’s equivalent to an interest-free loan, which is more of a benefit than a cost.”
“But, David, what about extra selling and administrative costs? Haven’t you left those out?”
“That’s the beauty of this, Lian. Given the recent recession, I figure we can handle the added business with existing personnel. In fact, one of the virtues of the proposal is that we should be able to retain some people we would otherwise have to terminate.”
“Well, you’ve convinced me, David. Now, I think it will be only fair if the boss puts you in charge of this exciting new project.” LO.1