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 $1.9 million for this​ report, and I am not sure their analysis makes sense. Before we spend the $24 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 28.000 16.800 Sales revenue - Cost of goods sold = Gross profit General, sales, and administrative expenses - Depreciation = Net operating income - Income tax 28.000 16.800 11.200 1.920 2.400 28.000 16.800 11.200 1.920 2.400 6.880 2.408 4.472 11.200 1.920 2.400 6.880 2.408 28.000 16.800 11.200 1.920 2.400 6.880 2.408 6.880 2.408 4.472 = Net income 4.472 4.472

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 45% on the equipment for tax purposes. The report concludes that because the project will increase earnings by $4.472 million per year for 10​ years, the project is worth $44.72 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 $13 million in working capital up front​ (year 0), which will be fully recovered in year 10. Next you see they have attributed $1.92 million of​ selling, general and administrative expenses to the​ project, but you know that $0.96 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!

THE QUESTIONS ARE:

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?

1. The free cash flow for year 0 is $___ million. ​(Round to three decimal​ places, and enter a decrease as a negative ​number.)

2. The free cash flow for year 1 is $___ million. ​(Round to three decimal​ places, and enter a decrease as a negative​ number.)

3. The free cash flow for year 2 is $___ million. ​(Round to three decimal​ places, and enter a decrease as a negative​ number.)

4. The free cash flow for year 3 is $___ million. ​(Round to three decimal​ places, and enter a decrease as a negative​ number.)

5. The free cash flow for year 4 is $___ million. ​(Round to three decimal​ places, and enter a decrease as a negative​ number.)

6. The free cash flow for year 5 is $___ million. ​(Round to three decimal​ places, and enter a decrease as a negative​ number.)

7. The free cash flow for year 6 is $___ million. ​(Round to three decimal​ places, and enter a decrease as a negative​ number.)

8. The free cash flow for year 7 is $___ million. ​(Round to three decimal​ places, and enter a decrease as a negative​ number.)

9. The free cash flow for year 8 is $___ million. ​(Round to three decimal​ places, and enter a decrease as a negative ​number.)

10. The free cash flow for year 9 is $___ million. ​(Round to three decimal​ places, and enter a decrease as a negative​ number.)

11. The free cash flow for year 10 is $___ million. ​(Round to three decimal​ places, and enter a decrease as a negative​ number.)

I really need help on this because I have been stuck for hours. Any help is greatly appreciated, i'll be sure to leave a good review :)

Answer 1

Statment of Annual Cashflow After Tax:

Particulars	Amount (in millions of dollars)
Sales Revenue	$                                                  28.000
Less: Cost of Goods Sold	$                                                  16.800
Gross Profit	$                                                  11.200
Less: General, Sales and Administrative Expenses (1.92 - 0.96)	$                                                     0.960
Less: Depreciation	$                                                     2.400
Net Operating Income	$                                                     7.840
Less: Income Tax @ 45%	$                                                     3.528
Net Income	$                                                     4.312
Add: Depreciation	$                                                     2.400
Cashflow After Tax	$                                                     6.712

Statement of Cashfow for the enire proposed project life:

Particulars	Year 0 (in millions of dollars)	Year 1 to 9 (in millions of dollars)	Year 10 (in millions of dollars)
Annual Cashflow After Tax	$                                                            -	$                                                         6.712	$                                                   6.712
Working Capital	$ (13.000)	$                                                                -	$                                                13.000
New Equipment	$ (24.000)	$                                                                -	$                                                          -
Net Cashflow	$ (37.000)	$                                                         6.712	$                                                19.712

Note: Consultants fee of $ 1.90 million is irrelevant for decision making because it is a sunk cost/historical cost.