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 $1.3 million for this​ report, and I am not sure their analysis makes sense. Before we spend the $18 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 Icon located on the​ top-right corner of the data table below in order to copy its contents into a​ spreadsheet.)

	Project Year
Earnings Forecast​ ($ million)	1	2	. . .	9	10
Sales revenue	32.000	32.000		32.000	32.000
minus−Cost of goods sold	19.200	19.200		19.200	19.200
equals=Gross profit	12.800	12.800		12.800	12.800
minus−​Selling, ​general, and administrative expenses	1.440	1.440		1.440	1.440
minus−Depreciation	1.800	1.800		1.800	1.800
equals=Net operating income	9.560	9.560		9.560	9.560
minus−Income tax	3.346	3.346		3.346	3.346
equals=Net unlevered income	6.214	6.214		6.214	6.214

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 $ 6.214 million per year for ten​ years, the project is worth $62.14 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 $ 1.44 million of​ selling, general and administrative expenses to the​ project, but you know that $0.72 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 14% what is your estimate of the value of the new​ project?

_______________________________________

FCF for year 0 is = $_______  (Round to three decimal places and enter a decrease as a negative​ number.)

FCF for year 1-9 is = $_______  (Round to three decimal places and enter a decrease as a negative​ number.)

FCF for year 10 is = $_______ (Round to three decimal places and enter a decrease as a negative​ number.)

NPV of project at 14% = $______ (Round to three decimal places and enter a decrease as a negative​ number.)

Answer 1