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 $1.3 million for this report, and I am not sure their analysis makes sense. Before we spend the $21 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 thousands of dollars):

Project Year 1 2 N 9 10 Sales revenue 28,000 28,000 28,000 28,000

- Cost of goods sold 16,800 16,800 16,800 16,800

= Gross profit 11,200 11,200 11,200 11,200

- General, sales, and administrative expenses 1,680 1,680 1,680 1,680

- Depreciation 2,100 2,100 2,100 2,100

= Net operating income 7,420 7,420 7,420 7,420

- Income tax 2,597 2,597 2,597 2,597 Net Income 4,823 4,823 4,823 4,823 All of the estimates in the report seem correct. You note that the consultants used straightline 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 $4.823 million per year for 10 years, the project is worth

$48.23 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 that the project will require $15 million in working capital upfront (year 0), which will be fully recovered in year