Hilary Maskona, the CEO of AllVax, met with her advisor, Vincent Purell, to review a capital-expenditure proposal on a production plant to produce COVID-19 vaccines using mRNA technology. The proposal, named the AntiCov Flow project, calls for an expenditure of $9 million spread over three years to convert an existing production plant from batch to continuous-flow technology and to install sophisticated state-of-the-art process controls throughout the plant. This project is only feasible with a continuous source of cationic lipids from a chemical synthesis process conducted in a specialized manufacturing facility. The proposal suggests AllVax purchase this type of manufacturing facility from a supplier (rather than sourcing the cationic lipids from two separate suppliers). AllVax has an option to exclusively purchase the cationic lipids facility from a supplier for $4 million (included in the proposed $9 million expenditure). The option was purchased several years earlier. Vincent advises the CEO that a comparable cationic lipids manufacturing facility can be sold today for $7 million in an auction. Vincent also forecasts that at the end of the project, the value of the cationic lipids manufacturing facility will be $30 million. This option will expire in 5 months.

The proposal will require the plant to be shut down for 5 months in the 1st year, 4 months in the 2nd year, and 3 months in the 3rd year. Vincent believes the loss will not be permanent. The benefits include an increase of 6% in new output gain on old output [new output = old output x (1+6%)] and an increase of 3% in gross margin on old gross margin of 11.5% (new gross margin = old gross margin + gross margin increase). The increased outputs will necessitate additional work-in-process inventory in value to 3% of the increased cost of goods. Vincent suggests that new assets will be fully depreciated on a straight-line basis over the life of the project. It is AllVax's policy to record depreciation expenses in the same year as expenditures. Vincent also estimates that overhead costs are at 3.5% of the increased sales. Inflation is set at 0%.

It is AllVax's policy to evaluate projects based on four criteria: (1) net present value, (2) internal rate of return, (3) payback, and (4) growth in earnings per share. Your task is to examine Vincent's analysis and make adjustments where necessary.

Assumptions (Financial values in millions of Australian Dollars)

Annual Output (metric tons) 260,000

Maximum Possible Output 286,000

New Output Gain on Old Output 6.0%

Old Gross Margin 11.5%

Gross margin increase 3.00%

Discount rate 10.0%

Overhead/Sales 3.5%

Price/ton (dollars) 541

Salvage Value 0

Tax Rate 30.0%

Inflation (prices and costs) 0.0%

WIP Inventory/Cost of Goods Sold 3.0%

Terminal Value of Specialised Manufacturing Facility 30

Number of shares outstanding 200,000,000

Investment Outlay (millions) Now 4

2021 3

2022 1

2023 1

Months Downtime, Construction 2021 5

2022 4

2023 3

Spreadsheet of Free cash flow

Year Now 2021 2022 2023 2024 2025

1. Estimate of Incremental Gross Profit

New Output

Lost Output--Construction

New Sales (Millions)

New Gross Margin

New Gross Profit

Old Output 260,000 260,000 260,000 260,000 260,000

Old Sales 140.66 140.66 140.66 140.66 140.66

Old Gross Profit 16.18 16.18 16.18 16.18 16.18

Incremental Gross Profit

2. Estimate of Incremental Depreciation

Yr. 0 Outlays

Yr. 1 Outlays

Yr. 2 Outlays

Yr. 3 Outlays

Total, New Depreciation

3. Overhead

4. Pretax Incremental Profit

5. Tax Expense

6. After-tax Profit

7. Cash Flow Adjustments

Add back Depreciation

Less additional WIP inventory

WIP Inventory Recovery

Capital Spending

Terminal Value, land

8. Free Cash Flow

Could you plz help me with the Spreadsheet of Free cash flow, and show me the workings. Thank!

Also, I'm confused about "AllVax has an option to exclusively purchase the cationic lipids facility". Will this option affect the free cash flow or any evaluation of this project?