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 $1.8 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):

	Project Year
Earnings Forecast? ($000,000s)	1	2	. . .	9	10
Sales revenue	34.000	34.000		34.000	34.000
?Cost of goods sold	20.400	20.400		20.400	20.400
=Gross profit	13.600	13.600		13.600	13.600
- ?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	10.5400	10.5400		10.5400	10.5400
?Income tax	3.689	3.689		3.689	3.689
=Net income	6.851	6.851		6.851	6.851

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. Canada Revenue Agency allows a CCA rate of 30% on the equipment for tax purposes. The report concludes that because the project will increase earnings by $6.851 million per year for ten? years, the project is worth $68.51 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 $7 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!b. If the cost of capital for this project is 16%?, what is your estimate of the value of the new? project?

b. If the cost of capital for this project is 16%?, what is your estimate of the value of the new? project?   

Value of project equals= $ ---- million (Round to three decimal? places.)

Answer 1

THE VALUE OF THE PROJECT = NPV = 22.032

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