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 $1.400 million for this report, and I am not sure their analysis makes sense. Before we spend the $22.600 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): 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 $7.846 million per year for 10 years, the project is worth $78.460 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 $9.200 million in working capital up front (year 0), which will be fully recovered in year 10. Next, you see they have attributed $1.808 million of selling, general, and administrative expenses to the project, but you know that $0.904 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 12%, what is your estimate of the value of the new project?

Year 1 2 . . . 9 10 Sales Revenue 35.000 35.000 35.000 35.000 Cost of Goods Sold 21.000 21.000 21.000 21.000 Gross Profit 14.000 14.000 14.000 14.000 Selling, General, and Administrative Expenses 1.808 1.808 1.808 1.808 Depreciation 2.260 2.260 2.260 2.260 EBIT 9.932 9.932 9.932 9.932 Income Tax 2.086 2.086 2.086 2.086 Net Income 7.846 7.846 7.846 7.846