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

$1.9

million for this report, and I am not sure their analysis makes sense. Before we spend the

$22

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):(Click on the following icon

in order to copy its contents into a spreadsheet.)

	Project Year
Earnings Forecast ($ million)	1	2	. . .	9	10
Sales revenue	28.000	28.000		28.000	28.000
Cost of goods sold	16.800	16.800		16.800	16.800
=Gross profit	11.200	11.200		11.200	11.200
Selling, general, and administrative expenses	1.760	1.760		1.760	1.760
Depreciation	2.200	2.200		2.200	2.200
=Net operating income	7.240	7.240		7.240	7.240
Income tax	1.448	1.448		1.448	1.448
=Net unlevered income	5.792	5.792		5.792	5.792

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. The report concludes that because the project will increase earnings by

$5.792

million per year for ten years, the project is worth

$57.92

million. You think back to your halcyon days in finance class and realize there is more work to be done!

First, you note that the consultants have not factored in the fact that the project will require

$12

million in working capital upfront (year 0), which will be fully recovered in year 10. Next, you see they have attributed

$1.76

million of selling, general and administrative expenses to the project, but you know that

$0.88

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?

what is your estimate of the value of the new project?

Can you please explain where 0.704 came from, thank you

Year 1 2 9 Free Cash Flow ($ million) = Net unlevered income + Overhead (after tax at 20%) + Depreciation - CapEx - Inc. in NWC Free Cash Flow 5.792 10.704 2.200 5.792 0.704 2.200 5.792 0.704 2.200 8.696 8.696 8.696