You are evaluating a new product. In year 3 of your​ analysis, you are projecting pro forma sales of ​$4.64.6 million and cost of goods sold of ​$2.762.76 million. You will be depreciating a ​$1.41.4 million machine for 55 years using​ straight-line depreciation. Your tax rate is 2121​%. ​Finally, you expect net working capital to increase from ​$210 comma 000210,000 in year 2 to ​$305 comma 000305,000 in year 3. What are your pro forma earnings for year​ 3? What is your pro forma free cash flow for year​ 3?
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Part 1
Complete the following pro forma statement.  ​(Round to the nearest​ dollar.)
Pro Forma Income Statement
 
Year 3
Sales
$
4600000
COGS
76000000
Depreciation
 
	
EBIT
$
7080000
Tax
 
148680000.00%
Earnings
$
 
Add Back Depreciation
 
Subtract Change in NWC
 
 
Free Cash Flow
$
 
 

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.

You are evaluating a new product. In year 3 of your analysis, you are projecting pro forma sales of $4.6 million and cost of goods sold of $2.76 million. You will be depreciating a $1.4 million machine for 5 years using straight-line depreciation. Your tax rate is 21%. Finally, you expect net working capital to increase from $210,000 in year 2 to $305,000 in year 3. What are your pro forma earnings for year 3? What is your pro forma free cash flow for year 3?

Explore the calculation of pro forma earnings and free cash flow for a new product in year 3, with projected sales of $4.6 million, COGS of $2.76 million, and depreciation on a $1.4 million machine over 5 years. The tax rate is 21%, and NWC increases from $210,000 to $305,000.

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