You are a manager at PercolatedFibre, which is considering expanding its operations in synthetic fibre manufacturing. Your boss comes into youroffice, drops aconsultant's report on yourdesk, andcomplains, "We owe these consultants $1.1 million for thisreport, and I am not sure their analysis makes sense. Before we spend the $22.3 million on new equipment needed for thisproject, look it over and give me youropinion." You open the report and find the following estimates(in millions ofdollars):

Click on the attached image for the project's figures.

All of the estimates in the report seem correct. You note that the consultants usedstraight-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 theequipment, which is thecompany's assumption in this case. The report concludes that because the project will increase earnings by $5.310 million per year for tenyears, the project is worth $53.10 million. You think back to your glory days in finance class and realise there is more work to bedone!

First, you note that the consultants have not factored in the fact that the project will require $8.3 million in net working capital up front(year 0), which will be fully recovered in year 10.Next, you see they have attributed $1.784 million ofselling, general and administrative expenses to theproject, but you know that $0.892 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 focuson!

a. Given the availableinformation, what are the free cash flows in years 0 to 10 that should be used to evaluate the proposedproject?

b. If the cost of capital for this project is 9%, what is your estimate of the value of the newproject?

a. The free cash flow for year 0 is $ ................ million.(Round to three decimalplaces.)

The free cash flow for years 1 to 9 is $ ................ (Round to three decimalplaces.)

The free cash flow for year 10 is $ ................(Round to three decimalplaces.)

b. If the cost of capital for this project is 9%, the value of project is $ ................ (Round to three decimalplaces.)

You (should/should not) accept the project.(Choose the best answer from the bracket.)

Project year Earnings forecast 2 LO 10 Sales revenue 29.000 29.000 29.000 29.000 - Cost of goods sold 17.400 17.400 17.400 17.400 = Gross profit 11.600 11.600 11.600 11.600 - General, sales and administrative expenses 1.784 1.784 1.784 1.784 - Depreciation 2.230 2.230 2.230 2.230 = Net operating profit 7.586 7.586 7.586 7.586 - Income tax 2.276 2.276 2.276 2.276 = Net profit 5.310 5.310 5.310 5.310