Question

You are a manager at Northern​ Fibre, which is considering expanding its operations in synthetic fibre manufacturing. Your boss comes into your​ office, drops a​ consultant's report on your​desk, and​ complains, "We owe these consultants $ 1.6million for this​ report, and I am not sure their analysis makes sense. Before we spend the $26million 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):

	1	2	. . .	9	10
Sales revenue	32.000	32.000		32.000	32.000
−Cost of goods sold	19.200	19.200		19.200	19.200
=Gross profit	12.800	12.800		12.800	12.800
−​General, ​sales, and administrative expenses	2.080	2.080		2.080	2.080
−Depreciation	2.600	2.600		2.600	2.600
=Net operating income	8.120	8.120		8.120	8.120
−Income tax	2.842	2.842		2.842	2.842
=Net income	5.278	5.278		5.278	5.278

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 for financial reporting purposes. CRA allows a CCA rate of 30% on the equipment for tax purposes. The report concludes that because the project will increase earnings by $5.278 million per year for 10​ years, the project is worth $52.78 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 factored in the fact that the project will require $15 million in working capital up front​(year 0), which will be fully recovered in year 10. Next you see they have attributed $2.08 million of​ selling, general and administrative expenses to the​ project, but you know that $1.04 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?

Answer 1