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 consultants report on your desk, and complains, We owe these consultants $1.3 million for this report, and I am not sure their analysis makes sense. Before we spend the $23.3 million on new equipment needed for this project, look 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 $3.774 million per year for the next 10 years, the project is worth $37.74 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 $8.2 million in working capital up front (year 0), which will be fully recovered in year 10.

Next, you see that they have attributed $1.864 million of selling, general, administrative expenses to this project, but you know that $0.932 million of this amount is overhead that will be incurred even if the project is not accepted.

Finally, you know that the 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 13%, what is your estimate of the value of the new project?

A.

1. The free cash flow for year 0 is $- million? (Round to three decimal places.)

2. The free cash flow for years 1 to 9 is $ million? (Round to three decimal places.)

3. The free cash flow for year 10 is $ million? (Round to three decimal places.)

B.

1. If the cost of capital for this project is 13%, the value of the project is $___ million? (Round to three decimal places.)

2. You SHOULD or SHOULD NOT accept the project? (Choose SHOULD or SHOULD NOT)

Earnings Forecast Sales Revenue - Cost of Goods Sold = Gross Profit - General, Sales and Administrative Expenses - Depreciation = Net Operating Income - Income Tax = Net Income 25.000 15.000 10.000 1.864 2.330 5.806 2.032 3.774 Project Year 2 25.000 15.000 10.000 1.864 2.330 5.806 2.032 3.774 9 25.000 15.000 10.000 1.864 2.330 5.806 2.032 3.774 10 25.000 15.000 10.000 1.864 2.330 5.806 2.032 3.774