Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

omplete the steps below using cell references to given data or previous calculations. In some cases, a simple cell reference is all you need.

"omplete the steps below using cell references to given data or previous calculations. In some cases, a simple cell reference is all you need. To copy/paste a formula across a row or down a column, an absolute cell reference or a mixed cell reference may be preferred. If a specific Excel function is to be used, the directions will specify the use of that function. Do not type in numerical data into a cell or function. Instead, make a reference to the cell in which the data is found. Make your computations only in the blue cells highlighted below. In all cases, unless otherwise directed, use the earliest appearance of the data in your formulas, usually the Given Data section.
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 consultants 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 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
12...910
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
Selling, General, and
Administrative Expenses $2,000 $2,000 $2,000 $2,000
Depreciation $2,500 $2,500 $2,500 $2,500
= EBIT $7,500 $7,500 $7,500 $7,500
Income Tax $1,575 $1,575 $1,575 $1,575
Net income $5,925 $5,925 $5,925 $5,925
"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. They also calculated the depreciation assuming no salvage value for the equipment, which is the companys assumption in this case. The report concludes that because the project will increase earnings by $5.925 million per year for 10 years, the project is worth $59.25 million. You think back to your glory days in finance class and realize there is more work to be done!
First, you note that the consultants have not included 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 $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!"
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 14%, what is your estimate of the value of the new project?
Tax Rate 21%
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?
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Cost of Machine -$25,000
Change in Net Working Capital -$10,000
Sales Revenue $30,000 $30,000 $30,000 $30,000 $30,000
Minus Cost of Goods Sold $18,000 $18,000 $18,000 $18,000 $18,000
Equals Gross Profit
Minus Selling, General, and Administrative Expenses
$2,000 $2,000 $2,000 $2,000 $2,000
Plus Overhead that would have occurred anyway
$1,000 $1,000 $1,000 $1,000 $1,000
Minus Depreciation $2,500 $2,500 $2,500 $2,500 $2,500
Equals Net Operating Income
Minus Income Tax
Equals Net Income
Plus Depreciation $2,500 $2,500 $2,500 $2,500 $2,500
Cost of Machine plus Change in Net Working Capital
$0 $0 $0 $0 $0
Equals Cash Flow
b. If the cost of capital for this project is 14%, what is your estimate of the value of the new project?
Cost of Capital 14%
NPV

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Handbook Of Asian Finance Financial Markets And Sovereign Wealth Funds

Authors: David Lee, Greg N. Gregoriou

1st Edition

0128009829, 978-0128009826

More Books

Students also viewed these Finance questions

Question

3. Describe the communicative power of group affiliations

Answered: 1 week ago