You are a manager at Percolated Fiber, which is considering adding a new product line. Your boss said to you We already owe these consultants $1.2 million, and all they estimated is Net Income. Before we spend $54 million on new equipment for this project, look the report over and give me your opinion. Here are the reports estimates (in millions of dollars; note that the question is continued below, so you need to scroll down to see it all):

1 2 3

Sales revenue 77.0 77.0 77.0

Cost of goods 42.0 42.0 42.0

Gross profit 35.0 35.035.0

Selling, gen. & admin. exp. 4.0. 4.0 4.0

-Depreciation 18.0 18.0 18.0

Net operating income13.0 13.0 13.0

- Income tax (30%)3.0 3.0 3.0

Net Income 10.0 10.0 10.0

Everything that the consultants have calculated is correct, as far as it goes. The project will require $ 5 million in working capital upfront (year 0), which will be fully recovered in the last year of the project (year 3). The project will also utilize other equipment that the consultants did not value separately because the equipment is already owned and not being used in other projects. The equipment could instead be donated to a charity, and the tax benefit of that donation would be $ 3.5 million (in other words, this is the total amount that your taxes would decrease by in period 0, if you donated the equipment rather than using it for the project). In addition, donating the equipment would also generate goodwill and increased reputation which you feel would be worth another $ 0.5 million (in dollars today). Unfortunately, some of the benefits of this new product line would be from customers switching from your existing products. This erosion or cannibalization would have a net (after tax) effect of $3 million per year lost from other products, over the three years you would be producing the new product. What are the correct free cash flows (FCFs) to be used when evaluating this project? Report them in millions of dollars, not in dollars. Note that the answer is NOT the NPV, but the incremental FCFs needed for each relevant period.

The project will also utilize other equipment that the consultants did not value separately because the equipment is already owned and not being used in other projects. The equipment could instead be donated to a charity, and the tax benefit of that donation would be $3.5 million (in other words, this is the total amount that your taxes would decrease by in period 0 , if you donated the equipment rather than using it for the project). In addition, donating the equipment would also generate goodwill and increased reputation which you feel would be worth anoither $0.5 milllon (in dollars today\}. Unfortunately, some of the benefits of this new product line would be from customers switching from your existing products. This erosion or cannibalization would have a net (after tax) effect of $3 million per year lost from other products, over the three years you would be producing the new product What are the correct free cash flows (FCFs) to be used when evaluating this project? Report them in millions of dollars, not in dollars. Note that the answer is NOT the NPV, but the incremental FCFs needed for each relevant period. Hints: (a) Start from the correct Net Income which has already been given. (b) Make any additional adjustments needed for each relevant period, in order to get the final, complete set of FCFs. (c) We worked two variations of this problem (Percolated Fiber) in the class slides, so see the slicies if you're not sure how to approach it. Again, the FCFs should be expressed in millions of dollars to one decimal place (but do not include a dellar sign). The first relevant period's FCF is: 63 The second relevant period's FCF is 25 The third relevant period's FCF is: 25 The last period's FCF is: 307 The project will also utilize other equipment that the consultants did not value separately because the equipment is already owned and not being used in other projects. The equipment could instead be donated to a charity, and the tax benefit of that donation would be $3.5 million (in other words, this is the total amount that your taxes would decrease by in period 0 , if you donated the equipment rather than using it for the project). In addition, donating the equipment would also generate goodwill and increased reputation which you feel would be worth anoither $0.5 milllon (in dollars today\}. Unfortunately, some of the benefits of this new product line would be from customers switching from your existing products. This erosion or cannibalization would have a net (after tax) effect of $3 million per year lost from other products, over the three years you would be producing the new product What are the correct free cash flows (FCFs) to be used when evaluating this project? Report them in millions of dollars, not in dollars. Note that the answer is NOT the NPV, but the incremental FCFs needed for each relevant period. Hints: (a) Start from the correct Net Income which has already been given. (b) Make any additional adjustments needed for each relevant period, in order to get the final, complete set of FCFs. (c) We worked two variations of this problem (Percolated Fiber) in the class slides, so see the slicies if you're not sure how to approach it. Again, the FCFs should be expressed in millions of dollars to one decimal place (but do not include a dellar sign). The first relevant period's FCF is: 63 The second relevant period's FCF is 25 The third relevant period's FCF is: 25 The last period's FCF is: 307