Question

Colsen Communications is trying to estimate the first-year cash flow (at Year 1) for a proposed project. The financial staff has collected the following information on the project: Sales revenues $20 million Operating costs (excluding depreciation) 14 million Depreciation 4 million Interest expense 4 million The company has a 40% tax rate, and its WACC is 13%. Write out your answers completely. For example, 13 million should be entered as 13,000,000. What is the project's cash flow for the first year (t = 1)? Round your answer to the nearest dollar. $ If this project would cannibalize other projects by $2 million of cash flow before taxes per year, how would this change your answer to part a? Round your answer to the nearest dollar. The firm's project's cash flow would now be $ . Ignore part b. If the tax rate dropped to 35%, how would that change your answer to part a? Round your answer to the nearest dollar. The firm's project's cash flow would by $

Answer 1

Answer:

(i) $5,200,000

(ii) $4,000,000

(iii) $5,300,000

Explanation:

(a) Profits before tax:

= Sales - costs - Depreciation

= $20 - $14 - $4

= $2 million

Net operating income = Profits before tax - Tax @40%

                                     = $2,000,000 - $800,000

                                     = $1,200,000

Project's cash flow for the first year:

= Net operating income + Depreciation

= $1,200,000 + $4,000,000

= $5,200,000

(b) Profits before tax:

= Sales - costs - Depreciation

= $20 - $14 - $4

= $2 million

Operating cash flows year:

= Profits before tax - Cannibalize effect + Depreciation

= $2,000,000 - $2,000,000 + $4,000,000

= $4,000,000

(c) Profits before tax:

= Sales - costs - Depreciation

= $20 - $14 - $4

= $2 million

Net operating income = Profits before tax - Tax @35%

                                     = $2,000,000 - $700,000

                                     = $1,300,000

Operating cash flows year:

= Net operating income + Depreciation

= $1,300,000 + $4,000,000

= $5,300,000

Operating cash flows will increase by $100,000.