Hello. You are a manager at NorthernFibre, which is considering expanding its operations in synthetic fibre manufacturing. Your boss comes into youroffice, drops aconsultant's report on yourdesk, andcomplains, "We owe these consultants $1.9 million for thisreport, and I am not sure their analysis makes sense. Before we spend the $ 17 million on new equipment needed for thisproject, look it over and give me youropinion." You open the report and find the following estimates(in millions ofdollars) - FILE ATTACHED. Consultants usedstraight-line depreciation for the new equipment that will be purchased today(year 0), which is what the accounting department recommended for financial reporting purposes. Canada Revenue Agency allows a CCA rate of 20 % on the equipment for tax purposes. The report concludes that because the project will increase earnings by $ 6.591 million per year for tenyears, the project is worth $ 65.91 million.

First, you note that the consultants have not factored in the fact that the project will require $ 10 million in working capital up front(year 0), which will be fully recovered in year 10.Next, you see they have attributed $ 1.36 million ofselling, general and administrative expenses to theproject, but you know that $ 0.68 million of this amount is overhead that will be incurred even if the project is not accepted. If the cost of capital for this project is 13 %

Project Yea Earnings Forecast ( 5000 00 05 ) 2 9 O Sales revenue 33.090 33.090 33 090 33000 Cost of goods sold 19800 19.800 19.800 19.800 Gross profit 3 . 200 13.200 13. 200 13. 200 General , sales and administrative expenses 360 360 360 360 Depreciation 700 700 700 1700 Net operating income 10 1400 10 1400 0.1400 10.1400 Income tax 3 549 3. 549 3. 549 3 549 Net income 6. 59 6.59 6.591 6.59