a) Arnold Inc. is considering a proposal to manufacture high-end protein bars used as food supplements by body builders. The project requires use of an existing warehouse, which the firm acquired three years ago for 1 million and which it currently rents out for 120,000 per year. Rental rates are not expected to change in the near future. In addition to using the warehouse, the project requires an up-front investment into machines and other equipment of 1.4m. This investment can be fully depreciated straight-line over the next 10 years for tax purposes. However, Arnold Inc. expects to terminate the project at the end of eight years and to sell the machines and equipment for 500,000. Finally, the project requires an initial investment into net working capital equal to 10% of predicted first-year sales. Subsequently, net working capital is 10% of the predicted sales over the following year. Sales of protein bars are expected to be 4.8 million in the first year and to stay constant for eight years. Total manufacturing costs and operating expenses (excluding depreciation) are 80% of sales, and profits are taxed at 30%.

i. What are the free cash flows of the project? ii. If the cost of capital is 15%, what is the NPV of the project?

b) You are an analyst working for Goldman Sachs, and you are trying to value the growth potential of a large established company Big Industries. Big Industries has a thriving R&D division that has consistently turned out successful products. You estimate that, on average, the R&D division generates two new product proposals every three years, so that there is a 66% chance that a project will be proposed every year. Typically, the investment opportunities the R&D division produces require an initial investment of 10 million and yield profits of 1 million per year that grow at one of three possible growth rates in perpetuity: 3%, 0%, and 3%. All three growth rates are equally likely for any given project. These opportunities are always "take it or leave it" opportunities: If they are not undertaken immediately, they disappear forever. Assume that the cost of capital will always remain at 12% per year. What is the present value of all future growth opportunities Big Industries will produce?

[15 marks]