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Part $1$

You are a manager at Percolated$$ Fibre, which is considering expanding its operations in synthetic fibre manufacturing. Your boss comes into your$$ office, drops a$$ consultant's report on your$$ desk, and$$ complains, $"$We owe these consultants $ $1\mathrm{.}3$ million for this$$ report, and I am not sure their analysis makes sense. Before we spend the $ $20\mathrm{.}6$ 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 information into a spreadsheet.

Project year

Earnings forecast

$1$

$2$

$...$

$9$

$10$

Sales revenue

$34\mathrm{.}000$

$34\mathrm{.}000$

$34\mathrm{.}000$

$34\mathrm{.}000$

minusCost of goods sold

$20\mathrm{.}400$

$20\mathrm{.}400$

$20\mathrm{.}400$

$20\mathrm{.}400$

equalsGross profit

$13\mathrm{.}600$

$13\mathrm{.}600$

$13\mathrm{.}600$

$13\mathrm{.}600$

minus$$General$,$ sales and administrative expenses

$1\mathrm{.}648$

$1\mathrm{.}648$

$1\mathrm{.}648$

$1\mathrm{.}648$

minusDepreciation

$2\mathrm{.}060$

$2\mathrm{.}060$

$2\mathrm{.}060$

$2\mathrm{.}060$

equalsNet operating profit

$9\mathrm{.}892$

$9\mathrm{.}892$

$9\mathrm{.}892$

$9\mathrm{.}892$

minusIncome tax

$2\mathrm{.}968$

$2\mathrm{.}968$

$2\mathrm{.}968$

$2\mathrm{.}968$

equalsNet profit

$6\mathrm{.}924$

$6\mathrm{.}924$

$6\mathrm{.}924$

$6\mathrm{.}924$

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, which is the$$ company's assumption in this case. The report concludes that because the project will increase earnings by $ $6\mathrm{.}924$ million per year for ten$$ years, the project is worth $ $69\mathrm{.}24$ million. You think back to your glory days in finance class and realise there is more work to be$$ done!

$$First$,$ you note that the consultants have not factored in the fact that the project will require $ $9\mathrm{.}2$ million in net working capital up front$($year $0),$ which will be fully recovered in year $10.$ Next, you see they have attributed $ $1\mathrm{.}648$ million of$$ selling, general and administrative expenses to the$$ project, but you know that $ $0\mathrm{.}824$ million of this amount is overhead that will be incurred even if the project is not accepted.$$ Finally, you know that accounting earnings are not the right thing to focus$$ on$!$

a$.$ Given the available$$ information, what are the free cash flows in years $0$ to $10$ that should be used to evaluate the proposed$$ project?

b$.$ If the cost of capital for this project is $12\%,$ what is your estimate of the value of the new$$ project?

Question content area bottom

Part $1$

a$.$ The free cash flow for year $0$ is $$$

$$

enter your response here million.$($Round to three decimal$$ places.$)$

Part $2$

The free cash flow for years $1$ to $9$ is $$$

$$

enter your response here million.$($Round to three decimal$$ places.$)$

Part $3$

The free cash flow for year $10$ is $$$

$$

enter your response here million.$($Round to three decimal$$ places.$)$

Part $4$

b$.$ If the cost of capital for this project is $12\%,$ the value of project is $$$

$$

enter your response here million.$($Round to three decimal$$ places.$)$

Part $5$

You

$$

should

should not

accept the project.$($Choose the best answer from the drop down$$ menu.$)$

The free cash flow for year $0$ is $million.The free cash flow for years $1$ to $9$ is $million.The free cash flow for year $10$ is $million.If the cost of capital for this project is $12\%,$ the value of project is $million.Youaccept the project.