Etobicoke 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): \begin{tabular}{lrr} \hline & Year 1 & \multicolumn{1}{c}{ Year 2 } \\ \hline Revenues & 123.2 & 164.1 \\ Operating Expenses (other than depreciation) & 43.3 & 69.9 \\ CCA & 27.9 & 30.5 \\ Increase in Net Working Capital & 2.6 & 7.1 \\ Capital Expenditures & 34.1 & 42.7 \\ Marginal Corporate Tax Rate & $35 \%$ & $35 \%$ \\ \hline \end{tabular} a. What are the incremental earnings for this project for years 1 and 2? (Note: Assume any incremental cost of goods sold is included as part of operating expenses.) b. What are the free cash flows for this project for the first two years? a. Calculate the incremental earnings for Year 1 of this project below: (Round to one decimal place.) Incremental Earnings Forecast (millions) Sales Operating Expenses CCA EBIT Income tax at $35 \%$ Unlevered Net Income Year 1 $\$$ $\frac{\square}{\$ \square}$ \begin{tabular}{r} $\square$ \\ $\$ \square$ \\ \hline \hline \end{tabular}

Step 1 ：To answer this question, we first need to understand the concept of incremental earnings and free cash flows. Incremental earnings are the additional earnings that a company expects to generate by undertaking a certain project. Free cash flows, on the other hand, are the cash a company is able to generate after laying out the money required to maintain or expand its asset base. a. To calculate the incremental earnings, we need to subtract the operating expenses and taxes from the revenues. The formula for EBIT (Earnings Before Interest and Taxes) is Revenues - Operating Expenses - CCA (Capital Cost Allowance or Depreciation). The income tax is then calculated as 35% of the EBIT. The unlevered net income (incremental earnings) is EBIT - Income Tax. For Year 1: EBIT = 123.2 - 43.3 - 27.9 = 52 million dollars Income Tax = 35% of 52 = 18.2 million dollars Unlevered Net Income = 52 - 18.2 = 33.8 million dollars For Year 2: EBIT = 164.1 - 69.9 - 30.5 = 63.7 million dollars Income Tax = 35% of 63.7 = 22.3 million dollars Unlevered Net Income = 63.7 - 22.3 = 41.4 million dollars b. Free cash flows are calculated as Unlevered Net Income + Depreciation - Increase in Net Working Capital - Capital Expenditures. For Year 1: Free Cash Flow = 33.8 + 27.9 - 2.6 - 34.1 = 25 million dollars For Year 2: Free Cash Flow = 41.4 + 30.5 - 7.1 - 42.7 = 22.1 million dollars So, the incremental earnings for this project for years 1 and 2 are 33.8 million dollars and 41.4 million dollars respectively. The free cash flows for this project for the first two years are 25 million dollars and 22.1 million dollars respectively.