0. You are a manager at Percolated Fiber, which is considering expanding its ope
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0. You are a manager at Percolated Fiber, which is considering expanding its operations in s thetic fiber manufacturing. Your boss comes into your office, drops a consultant's report your desk, and complains, "We owe these consultants $1 million for this report, and I am nor sure their amlyis makes sense. Before we spend the $25 million on new equipment needed this project, look it over and give me your opinion." You open the report and find the followning estimates (in thousands of dollars): Project Year 10 Sales revenue - Cost of goods sold = Gross profit - General, sales, and 30,000 30,000 18,000 18,000 12,000 12,000 0 2,000 30,000 30,000 18,000 18,000 12,000 12,000 2,000 2 2,000 2,000 administrative expenses eciation 2,5002,500 7,5007,500 2,625 2,625 4,8754,875 2,500 2,500 7,500 2,625 4,875 Net operating income Income tax 7,500 2,625 4,875 Net IncomeExplanation / Answer
Every figure in thousands
Cost of new equipment = 25,000
Initial working capital required = 10,000
Sales for each year = 30,000
Cost of Goods Sold = 18,000
Gross Profit = 30,000 - 18,000 = 12,000
Selling, General and Administrative expense = 1,000 (it is given that 1,000 woll be incurredeven if project is not taken so when we calculate cash flows of projects we only inculde incremental cash flows i.e. the cash flows that is happening only if project is undertaken)
Depreciation = 2,500
Net Operating Income = 12,000 - 1,000 - 2,500 = 8,500
Income tax = 2,625
Net Income = 8,500 - 2,625 = 5,875
Cash flow = Net Income + depreciation - change in Net Working Capital
a.) Cash flow in year 0 = -25,000 -10,000 = -35,000 (negative sign indicates cash outflow)
Added 10,000 because this working capital is needed initially
Cash flow in year 1 to 9 = 5,875+2,500 = $8,375
Cash flow in Year 10 = 5,875 + 2,500 + 10,000 = 18,375 (10,000 is net working capital returned)
b) We will calculate value of project using NPV
NPV is sum of present value of all cash flows
Present value = Cash flow/(1+r)n, where r is required return and n is number of years
r is cost of capital i.e. 14%
NPV = CF0 + CF1/(1+r)1 + CF2/(1+r)2 + ............................. + CF9/(1+r)9 + CF10/(1+r)10
NPV = -35000 + 8375/(1.14)1 + 8375/(1.14)2 + .........................+ 8375/(1.14)9 + 18375/(1.14)10
NPV = 11,382.40663
The value of project is 11,382,406.63
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