Question 2. Capital investment You are the manager at Percolated Fibre Ltd which is considering expanding its operations in synthetic fibre manufacturing. Your boss recommends doing this project because it will have $525 000 in profits each year for the next five years, therefore he says the project's value is $5 250 000 which is clearly more than the $2 500 000 the equipment will cost. He recently paid $100 000 for a consultant's report that determined the $525 000 profit. You take a look and determine that the $525 000 came from expected sales revenue of $1 500 000, expected cost of goods sold of $415 000, expected selling, general and administrative expenses of $50 000 and interest expense of $35 000. The firm's marginal tax rate is 30%. You do some follow-up and determine that the equipment will be depreciated on a straight-line basis to zero. There will be additional inventory needed of $80 000. You also know that the selling, general and administrative expenses included overhead of $10 000. You know the firm uses an average cost of capital of 14%. Formulas are provided on the last pages of this question booklet. Required: a. What is the initial investment in this project? (3 marks) b. What is the operating cash flow for years 1-4 of the project? (9 marks) c. What is the year 5 cash flow of this project? (3 marks) d. What is the net present value of the project? (8 marks) e. Should you do the project? Why or why not? (2 marks) Question 2. Capital investment You are the manager at Percolated Fibre Ltd which is considering expanding its operations in synthetic fibre manufacturing. Your boss recommends doing this project because it will have $525 000 in profits each year for the next five years, therefore he says the project's value is $5 250 000 which is clearly more than the $2 500 000 the equipment will cost. He recently paid $100 000 for a consultant's report that determined the $525 000 profit. You take a look and determine that the $525 000 came from expected sales revenue of $1 500 000, expected cost of goods sold of $415 000, expected selling, general and administrative expenses of $50 000 and interest expense of $35 000. The firm's marginal tax rate is 30%. You do some follow-up and determine that the equipment will be depreciated on a straight-line basis to zero. There will be additional inventory needed of $80 000. You also know that the selling, general and administrative expenses included overhead of $10 000. You know the firm uses an average cost of capital of 14%. Formulas are provided on the last pages of this question booklet. Required: a. What is the initial investment in this project? (3 marks) b. What is the operating cash flow for years 1-4 of the project? (9 marks) c. What is the year 5 cash flow of this project? (3 marks) d. What is the net present value of the project? (8 marks) e. Should you do the project? Why or why not? (2 marks)
