Question: Elmdale Enterprises is deciding whether to expand its production facilities. Although long term cash flows are difficult to estimate, management has projected the following cash flows for the first two years (in millions of dollars).

Year 1 Year 2

Revenues 125 160

Cost of goods sold and operating expenses

other than depreciation 40 60

Depreciation 25 36

Increase in working capital 5 8

Capital expenditures 30 40

Marginal corporate tax rate 35% 35%

a. What are the incremental earnings for this project for year 1 and 2?

b. What are the free cash flows for this project for the first 2 years?