Question

You are a manager at Northern​ Fibre, which is considering expanding its operations in synthetic fibre 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 $17 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 millions of​dollars):

	1	2	. . .	9	10
Sales revenue	35.000	35.000		35.000	35.000
−Cost of goods sold	21.000	21.000		21.000	21.000
=Gross profit	14.000	14.000		14.000	14.000
−​General, ​sales, and administrative expenses	1.360	1.360		1.360	1.360
−Depreciation	1.700	1.700		1.700	1.700
=Net operating income	10.940	10.940		10.940	10.940
−Income tax	3.829	3.829		3.829	3.829
=Net income	7.111	7.111		7.111	7.111

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 for financial reporting purposes. CRA allows a CCA rate of 30% on the equipment for tax purposes. The report concludes that because the project will increase earnings by $7.111 million per year for 10​ years, the project is worth $71.11 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 factored in the fact that the project will require $9 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 of​ selling, general and administrative expenses to the​ project, but you know that $0.68 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?

Answer 1

ANSWER

year	sales (A)	cost of goods sold (B)	add. general sales and administrative expenses(C)	depreciation	net profit after tax	tax amount (D)30%	cash flows from proposed project (A-B-C-D)	Working cap investment	new equipment purchase cost	Freecash flows from proposed project
0	-	-	-	-	-	-	-	-9	-17	-26
1	35	-21	-0.68	-1.7	11.62	-3.486	9.834	-	-	9.834
2	35	-21	-0.68	-1.7	11.62	-3.486	9.834	-	-	9.834
3	35	-21	-0.68	-1.7	11.62	-3.486	9.834	-	-	9.834
4	35	-21	-0.68	-1.7	11.62	-3.486	9.834	-	-	9.834
5	35	-21	-0.68	-1.7	11.62	-3.486	9.834	-	-	9.834
6	35	-21	-0.68	-1.7	11.62	-3.486	9.834	-	-	9.834
7	35	-21	-0.68	-1.7	11.62	-3.486	9.834	-	-	9.834
8	35	-21	-0.68	-1.7	11.62	-3.486	9.834	-	-	9.834
9	35	-21	-0.68	-1.7	11.62	-3.486	9.834	-	-	9.834
10	35	-21	-0.68	-1.7	11.62	-3.486	9.834	9	-	18.834
	ADDITIONAL GENERAL SALES AND ADMINISTRATIVE EXPENSES =1.36 -0.68

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