i did year 0 and got it right but i got year 1-3 wrong, shown in the text was the correct answers for year 1-3. what is the answers for year 4-10?

Question

You are a manager at Northern 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 $1.3 million for this report, and I am not sure their analysis makes sense. Before we spend the $30 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) for each year from 1 to 10:

• Sales revenue is $25 million.

• Cost of goods sold is $15 million.

• Gross profit is $10 million.

• General, sales, and administrative expenses are $2.4 million.

• Depreciation is $3 million.

• Net operating income is $4.6 million.

• Income tax is $1.61 million.

• Net income is $2.99 million.

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 for financial reporting purposes. However, the Canada Revenue Agency (CRA) allows a Capital Cost Allowance (CCA) rate of 30% on the equipment for tax purposes. The report concludes that because the project will increase earnings by $2.99 million per year for 10 years, the project is worth $29.9 million.

You realize there is more work to be done. First, you note that the consultants have not accounted for the fact that the project will require an $8 million investment in working capital upfront (year 0), which will be fully recovered in year 10. Next, you see that they have attributed $2.4 million of selling, general, and administrative (GSA) expenses to the project, but you know that $1.2 million of this amount is overhead that will be incurred even if the project is not accepted. Finally, you understand that accounting earnings are not the correct measure to evaluate this project.

Question:

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

Answer 1

So for calculating free cash flows, we will start with the EBITDA for each year and then make adjustments for it based on the following formula: EBITDA - interest expense - tax expense +/- changes in NWC - Capital expenditures. I have laid out the table below to find the total free cash flows from years 0-10.

Note 1: For the SGA expense line, I used $1.2M as that is the amount that is attributable to this project (2.4 - 1.2 = 1.2)

Note 2: We did not have any interest expenses or capital expenditures during the forecast period so we have left it out.

Note 3: To find the true value, we would have to find the present value of the future cash flow using a discount rate (which is usually the risk-free rate or the company's WACC). We are not provided a discount rate in the problem so we can't find the present value.

Answer:

Year: 0 1-10

Revenue: 0 25

COGS: 0 -15

Gross Profit: 0 10

SG&A: 0 -1.2

EBITDA: 0 8.8

Tax Exp: 0 -1.61

NWC change: -8 0

FCF: -8 7.19

Total FCF years 0-10: $63.9

Let me know if this makes sense!