Problem 4 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 $2.0 million for this report, and I am not sure their analysis makes sense. Before we spend the $26 million on new equipment needed for this project, look it over and give me your opinion." You open the report and find the following estimates. (In Millions) Project Year Earnings Forecast ($ million) 1 2 9 10 ... Sales revenue 27.000 27.000 27.000 27.000 -Cost of goods sold 16.200 16.200 16.200 16.200 = Gross profit 10.800 10.800 10.800 10.800 - Selling, general, and administrative expenses 2.080 2.080 2.080 2.080 - Depreciation 2.600 2.600 2.600 2.600 = Net operating income 6.120 6.120 6.120 6.120 - Income tax 1.224 1.224 1.224 1.224 Net unlevered income 4.896 4.896 4.896 4.896 Figure 2: Consultant Report 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 $4.896 million per year for 10 years, the project is worth $48.96 million. You think back to your halcyon days in your Principles of Engineering 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 $9 million in working capital upfront (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 $1.04 million of this amount is overhead that will be incurred even if the project is not accepted. Finally, you know that accounting earnings are not the right thing to focus on! (a) Free Cash Flow (FCF) (i) What is the FCF for year 0? What is the FCF for years 1 to 9? (iii) What is the FCF for year 10? (b) If the cost of capital for this project is 11%, what is your estimate of the value of the new project ($ Millions).