A purely equity financed firm is considering project ABC.

The project generates the following stream of net income $($i$.$e$.$

earnings after depreciation and tax$)$:

Year $1$ Year $2$$$5$ $$0$ in the bad state or $$8$ in the good state with equal

probability

The required investment at year $0$ is $$16,$ which is depreciated

using the straight$-$line method. At the end of year $2,$ the investment

can be sold for $$5.$

The project only requires $$5$ net working capital in year $1,$ which is

recovered at the end of the project.

Tax rate is $40\%.$ Assume that taxes are paid in the same year.

Discount rate is $10\%.$

a$)$ What is the free cash flow of project ABC in each year?

b$)$ What is the NPV of project ABC? Should we implement this project?