Question

Please use excel and show calculations

You are a Manager at Percolated Fiber, which is considering expanding its operations in synthetic fiber manufacturing. With your Group team accompanying you, your Boss, Mr. Moneypockets, asks you to come to his office, where he gives you a consultant's report 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 with your team and give me your opinion." You open the report and find the estimates at the bottom of page 268 (in your textbook).

So, continue with this case at the top of page 269, and answer these questions:

YEAR		0	1	2	…	7	8	9	10
Sales			30,000	30,000	30,000	30,000	30,000	30,000	30,000
COGS			18,000	18,000	18,000	18,000	18,000	18,000	18,000
Gross Profit			12,000	12,000	12,000	12,000	12,000	12,000	12,000
SGA			2,000	2,000	2,000	2,000	2,000	2,000	2,000
Deprecation			2,500	2,500	2,500	2,500	2,500	2,500	2,500
Net operating income			7,500	7,500	7,500	7,500	7,500	7,500	7,500
Income Tax			2,625	2,625	2,625	2,625	2,625	2,625	2,625
Net Income			4,875	4,875	4,875	4,875	4,875	4,875	4,875

a) given the available information, what are the free cash flows in years 0 through 10 that should be used to evaluate the project?

b) if the cost of capital for the project (that is, the WACC) is 13%, what is your estimate of the NPV for the new project? How does the IRR compare to the required WACC? Would you recommend to Mr. Moneypockets that this project be undertaken, and why?

c) what are some uncertainties in the FCFs that your team might see in these (presumed to be 100% correct) NPV and IRR metrics, that could cause them to not be as deterministic as you and your team are basically assuming in your presentation to Mr. Moneypockets?

Answer 1

YEAR			1
Sales			30,000
COGS			18,000
Gross Profit			12,000
SGA			2,000
Deprecation			2,500
Net operating income			7,500
Income Tax			2,625
Net Income			4,875
add depreciation			2,500
Net operating cash flow = free cash flow			7,375
Year	free cash flow	present value of cash flow = free cash flow/(1+r)^n r= 13%
0	-25000	-25000
1	7375	6526.549
2	7375	5775.707
3	7375	5111.245
4	7375	4523.226
5	7375	4002.855
6	7375	3542.349
7	7375	3134.822
8	7375	2774.179
9	7375	2455.026
10	7375	2172.589
Net present value	sum of present value of cash flow	15018.55
IRR	Using IRR function in MS excel	12.16%
IRR of the project is 12.16% which is less than the WACC of the company so according to IRR project should not be undertaken, while NPV is positive and its suggest that project should be undertaken. On the basis of NPV Project should be undertaken.
uncertanities related to free cash flow are concerned with time factor and various kind of risk involved in the project like default risk, inflation risk etc. due to which discount rate will change the decision related to project.