Chapter_11_Mini_Case_7th_Edition_

Chapter_11_Mini_Case_7th_Edition_ - Chapter 11 Mini Case...

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Chapter 11 Mini Case (7th Ed.) Caledonia Products A. We focus on free cash flows rather than accounting profits because these are t that the firm receives and can reinvest. Only by examining cash flows are we ab correctly analyze the timing of the benefit or cost. Also, we are only interested cash flows on an after-tax basis as only those flows are available to the shareh addition, it is only the incremental cash flows that interests us, because, lookin project from the point of view of the company as a whole, the incremental cash are the marginal benefits from the project and, as such, are the increased value firm from accepting the project. B. Although depreciation is not a cash flow item, it does affect the level of the diff cash flows over the project's life because of its effect on taxes. Depreciation is expense item and, the more depreciation incurred, the larger the expenses. Thu accounting profits become lower, and in turn, so do taxes which are a cash flow C. When evaluating a capital budgeting proposal, sunk costs are ignored. We are interested in only the incremental after-tax cash flows, or free cash flows, to the company as a whole. Regardless of the decision made on the investment at han sunk costs will have already occurred, which means these are not incremental flows. Hence, they are irrelevant. Data Given (Are Inputs to Sections Below) Cost of new plant and equipment Purchase Price* $7,900,000.00 $100,000.00 Inventory Increase = $100,000.00 Life* 5 Depreciation* $1,600,000.00 Salvage Value* 0 Tax Rate (Marginal)* 34% Required Rate of Return* 15% NWC/Revenues* 10% * Given Calculation of Change in EBIT, Taxes and Depreciation (Provides Inputs to Sec Year 0 Year 1 Year 2 Unit Sales* 70,000 120,000
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Sales Price per Unit* $300 $300 Revenues $21,000,000 $36,000,000 Variable Costs per Unit* $180 $180 Total Variable Costs $12,600,000 $21,600,000 Annual Fixed Costs* $200,000 $200,000 Total Costs $12,800,000 $21,800,000 EBDIT $8,200,000 $14,200,000 Less Depreciation $1,600,000 $1,600,000 EBIT $6,600,000 $12,600,000 Taxes* (34%) $2,244,000 $4,284,000 Net Income $4,356,000 $8,316,000 Calculate Operating Cash Flow (Is an Input to Section IV) EBIT $6,600,000 $12,600,000 Less Taxes -$2,244,000 -$4,284,000 Plus Depreciation $1,600,000 $1,600,000 Operating Cash Flow $5,956,000 $9,916,000 Easier Way Net Income $4,356,000 $8,316,000 + Depreciation $1,600,000 $1,600,000 + Interest $0 $0 Cash Flow from Operations $5,956,000 $9,916,000 Calculate Change in Net Working Capital (Is an Input to Section IV) Revenues $21,000,000 $36,000,000 Initial NWC Need* $100,000 NWC Need* (10% Sales) $2,100,000 $3,600,000 Liquidation of NWC Change in NWC $100,000 $2,000,000 $1,500,000 Calculate Free Cash Flow Operating Cash Flow $5,956,000 $9,916,000 Less Changes in NWC $100,000 $2,000,000 $1,500,000 $8,000,000.00 Free Cash Flow ($8,100,000) $3,956,000 $8,416,000 NPV = $16,731,095.66 PI =PV of FCF/IO 3.07 IRR = 77.02%
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J. Yes. This project should be accepted because the NPV ≥ 0. and the IRR ≥ requir
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This note was uploaded on 09/30/2011 for the course FIN 350 taught by Professor Chen during the Spring '07 term at S.F. State.

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Chapter_11_Mini_Case_7th_Edition_ - Chapter 11 Mini Case...

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