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

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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 $ 1.6 million for this report, and I am not sure their analysis makes sense. Before we spend the $ 23 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	29.000	29.000		29.000	29.000
Cost of goods sold	17.400	17.400		17.400	17.400
Gross profit	11.600	11.600		11.600	11.600
General, sales, and administrative expenses	1.840	1.840		1.840	1.840
Depreciation	2.300	2.300		2.300	2.300
Net operating income	7.4600	7.4600		7.4600	7.4600
Income tax	2.611	2.611		2.611	2.611
Net Income	4.849	4.849		4.849	4.849

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 $ 4.849 million per year for ten years, the project is worth $ 48.49 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 $ 8 million in working capital up front(year 0), which will be fully recovered in year 10. Next, you see they have attributed $ 1.84 million ofselling, general and administrative expenses to the project, but you know that $ 0.92 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. If the cost of capital for this project is

what is your estimate of the value of the new project?

Value of Project = $_____________ Million (Round to three decimal places.)

2) Buhler Industries is a farm implement manufacturer. Management is currently evaluating a proposal to build a plant that will manufacture lightweight tractors. Buhler plans to use a cost of capital of 12 % to evaluate this project. Based on extensive research, it has prepared the following incomplete incremental free cash flow projections (in millions of dollars):

Free Cash Flow ($000,000s)	Year 0	Years 1–9	Year 10
Revenues	93.00	93.00
Manufacturing expenses (other thandepreciation)	-33.00	−33.00
Marketing expenses	−9.00	−9.00
CCA	?	?
EBIT	?	?
Taxes (35%)	?	?
Unlevered net income	?	?
CCA	?	?
Increases in net working capital	−5.00	−5.00
Capital expenditures	−143.00
Continuation value	11.00
Free cash flow	−143.00	?	?

The relevant CCA rate for the capital expenditures is 10 % Assume assets are never sold.

2. A.) Using the indirect method requires a separate calculation of the CCA tax shield. What is the present value of the CCA tax shield?

The present value of the CCA tax shield is

$_________________

million. (Round to two decimal places.)

B.) For this base-case scenario, what is the NPV of the plant to manufacture lightweight

tractors?

The NPV is

$__________________ million. (Round to two decimal places.)

C.) Based on input from the marketing department, Buhler is uncertain about its revenue forecast. In particular, management would like to examine the sensitivity of the NPV to the revenue assumptions.

What is the NPV of this project if revenues are 10 % higher than forecast?

The NPV is

$__________________

million. (Round to two decimal places.)

D.) What is the NPV if revenues are

10 %lower than forecast?

The NPV is

$___________________________

million. (Round to two decimal places.)

3. 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 $ 1.9 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 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	26.000	26.000		26.000	26.000
Cost of goods sold	15. 600	5.600		15.600	15.600
Gross profit	10.400	10.400		10.400	10.400
General, sales, and administrative expenses	2.000	2.000		2.000	2.000
Depreciation	2.500	2.500		2.500	2.500
Net operating income	5.9000	5.9000		5.9000	5.9000
Income tax	2.065	2.065		2.065	2.065
Net Income	3.835	3.835		3.835	3.835

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 45 % on the equipment for tax purposes. The report concludes that because the project will increase earnings by

$ 3.835 million per year for ten years, the project is worth $ 38.35

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 $ 2 million of selling, general and administrative expenses to the project, but you know that $ 1$ 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!

3. Given the available information, what are the free cash flows in years 0 through 10 that should be used to evaluate the proposed project?

The free cash flow for year 0 is

$_____________