To calculate the pro forma earnings and free cash flow for Year 3, we can follow these steps:

Pro Forma Income Statement for Year 3

1. Sales: $4,600,000

2. Cost of Goods Sold (COGS): $2,760,000

3. Depreciation:

   • Cost of machine = $1,410,000
   • Useful life = 5 years
   • Annual Depreciation = $\frac{1,410,000}{5} = 282,000$

4. EBIT (Earnings Before Interest and Taxes): $\text{EBIT} = \text{Sales} - \text{COGS} - \text{Depreciation} = 4,600,000 - 2,760,000 - 282,000 = 1,558,000$

5. Tax:

   • Tax Rate = 21% $\text{Tax} = \text{EBIT} \times \text{Tax Rate} = 1,558,000 \times 0.21 = 327,180$

6. Earnings: $\text{Earnings} = \text{EBIT} - \text{Tax} = 1,558,000 - 327,180 = 1,230,820$

Calculation of Free Cash Flow for Year 3

1. Add Back Depreciation:

   • Add back the depreciation expense: $\text{Add Back Depreciation} = 282,000$

2. Change in Net Working Capital (NWC):

   • Increase in NWC = New NWC - Old NWC = $305,000 - $210,000 = $95,000
   • This amount is subtracted from the cash flow.

3. Free Cash Flow (FCF): \text{Free Cash Flow} = \text{Earnings} + \text{Depreciation} - \text{Change in NWC $\text{FCF} = 1,230,820 + 282,000 - 95,000 = 1,417,820$

Summary of Pro Forma Income Statement

Item	Amount
Sales	$4,600,000
COGS	$2,760,000
Depreciation	$282,000
EBIT	$1,558,000
Tax (21%)	$327,180
Earnings	$1,230,820
Add Back Depreciation	$282,000
Subtract Change in NWC	$95,000
Free Cash Flow	$1,417,820

Final Results

• Pro Forma Earnings for Year 3: $1,230,820
• Pro Forma Free Cash Flow for Year 3: $1,417,820

Would you like further details or explanations on any part of this calculation? Here are some related questions you might consider:

1. How does depreciation impact tax calculations?
2. What are the implications of increasing net working capital?
3. How do changes in sales projections affect earnings?
4. What other factors should be considered in cash flow projections?
5. How can free cash flow be utilized in business decisions?

Tip: Regularly updating your financial projections can help adjust for market changes and improve decision-making.