Caledonia Products - a.

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a. Caledonia should focus on free cash flows rather than accounting profits because free cash  flows can be reinvested.   Free cash flow is found by taking net operating income less  changes in working capital less capital expenditures.  b. Depreciation   does   affect   free   cash   flows   via   its   tax   implications.   More   specifically,  depreciation is a non-cash expense but has a positive effect on income tax expenses. c. If a capital budgeting proposal is under consideration by a firm, sunk costs are ignored  because they are unavoidable.  Investment decisions are made using relevant costs; namely  those cost which are not avoidable in order to ascertain if a project will be accepted. Section I.  Calculate the change in EBIT, Taxes, and Depreciation (this become an input in the  calculation of Operating Cash Flow in Section II). Year 0 1 2 3 Units Sold 70,000 120, 000 140,000 8 Sale Price $300  $30 $300  Sales Revenue $21,000,000  $36, 000, 000  $42,000,000  $24, Less: Variable Costs 12,600,000 21,6 00,0 00 25,200,000 14,4 Less: Fixed Costs $200,000  $20 0,00 $200,000  $200 Equals: EBDIT $8,200,000  $14, 200, 000  $16,600,000  $9,4 Less: Depreciation $1,600,000  $1,6 00,0 000  $1,600,0000  $1,6 Equals: EBIT $6,600,000  $12, 600, 000  $15,000,000  $7,8 Taxes (@34%) $2,244,000  $4,2 84,0 00  $5,100,000  $2,6
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Section II. Calculate Operating Cash Flow (this becomes an input in the calculation of Free 
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This note was uploaded on 03/01/2012 for the course ACCOUTNING 550 taught by Professor Abner during the Spring '11 term at DeVry Houston.

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Caledonia Products - a.

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