Question

You are a manager at Percolated​ Fiber, which is considering expanding its operations in synthetic fiber 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 $23.4 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	1	2	. . .	9	10
Sales Revenue	25.000	25.000		25.000	25.000
minus−Cost of Goods Sold	15.000	15.000		15.000	15.000
equals=Gross Profit	10.000	10.000		10.000	10.000
minus−​General, Sales and Administrative Expenses	1.872	1.872		1.872	1.872
minus−Depreciation	2.340	2.340		2.340	2.340
equals=Net Operating Income	5.788	5.788		5.788	5.788
minus−Income Tax	2.026	2.026		2.026	2.026
equals=Net Income	3.762	3.762		3.762	3.762

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. They also calculated the depreciation assuming no salvage value for the equipment. The report concludes that because the project will increase earnings by $3.762 million per year for 10​ years, the project is worth $37.62 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 included the fact that the project will require $8.1 million in working capital up front​ (year 0), which will be fully recovered in year 10.​ Next, you see they have attributed $1.872 million of​ selling, general, and administrative expenses to the​ project, but you know that $0.936 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. Given the available​ information, what are the free cash flows in years 0 through 10 that should be used to evaluate the proposed​ project?

b. If the cost of capital for this project is 10%​, what is your estimate of the value of the new​ project?

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?

The free cash flow for year 0 is

​$nothing

million.  ​(Round to three decimal​ places.)

Answer 1