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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

$22

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 following icon

in order to copy its contents into a spreadsheet.)

Earnings Forecast ($ million)

	Project Year
	1	2	. . .	9	10
Sales revenue	35.000	35.000		35.000	35.000
Cost of goods sold	21.000	21.000		21.000	21.000
=Gross profit	14.000	14.000		14.000	14.000
Selling, general, and administrative expenses	1.760	1.760		1.760	1.760
Depreciation	2.200	2.200		2.200	2.200
=Net operating income	10.040	10.040		10.040	10.040
Income tax	2.008	2.008		2.008	2.008
=Net unlevered income	8.032	8.032		8.032	8.032

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

$8.032

million per year for ten years, the project is worth

$80.32

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

$14

million in working capital upfront (year 0), which will be fully recovered in year 10. Next, you see they have attributed

$1.76

million of selling, general and administrative expenses to the project, but you know that

$0.88

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 proposedproject?

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. Given the available information, what are the free cash flows in years 0 through 10 that should be used to evaluate the proposedproject?

Answer & Explanation Solved by verified expert

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