Question

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$1.5 million for this​ report, and I am not sure their analysis makes sense. Before we spend the$20.4 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):

	Project Year
Earnings Forecast	1	2	. . .	9	10
Sales Revenue	29.000	29.000		29.000	29.000
- Cost of Goods Sold	17.400	17.400		17.400	17.400
=GrossProfit	11.600	11.600		11.600	11.600
−​General, Sales and Administrative Expenses	1.632	1.632		1.632	1.632
−Depreciation	2.040	2.040		2.040	2.040
=Net Operating Income	7.928	7.928		7.928	7.928
−Income Tax	2.775	2.775		2.775	2.775
=Net Income	5.153	5.153		5.153	5.153

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 $5.153 million per year for 10​ years, the project is worth $51.53 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 $13.5 million in working capital up front​ (year 0), which will be fully recovered in year 10.​ Next, you see they have attributed $1.632 million of​ selling, general, and administrative expenses to the​ project, but you know that $ 0.816 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 9 %​, what is your estimate of the value of the new​ project?

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?

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

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

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

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

If the cost of capital for this project is 9%

the value of the project is ??? million.  ​(Round to three decimal​ places.)

You a. should not

b. should

c. accept the project.  (Choose one)

Answer 1

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