Temporary Housing Services Incorporated (THSI) is considering a project that inv

Question

Temporary Housing Services Incorporated (THSI) is considering a project that involves setting up a temporary housing facility in an area recently damaged by a hurricane. THSI will lease space in this facility to various agencies and groups providing relief services to the area. THSI estimates that this project will initially cost $5 million to setup and will generate $20 million in revenues during its first and only year in operation (paid in one year). Operating expenses are expected to total $12 million during this year and depreciation expense will be another $3 million. THSI will require no working capital for this investment. THSI's marginal tax rate is 35%.

Ignoring the original investment of $5 million, what is THSI's free cash flow for the first and only year of operation?

$5.0 million

$3.75 million

$8.0 million

$6.25 million

$5.0 million

$3.75 million

$8.0 million

$6.25 million

Explanation / Answer

Free Cash Flow = EBIT(1 - Tax Rate) + Depriciation

Gievn,

Revenues = $ 20 million

Operating expenses = $ 12 million

Depriciation = $ 3 million

Tax Rate = 35%

So, Earning before interest & Taxes (but after depriciation)

= Sales - Operating Expenses - Depriciation

= 20 - 12 - 3

= $ 5 million

So, Free Cash Flow = 5 (1 - 0.35) + 3

= 3.25 + 3

= $ 6.25 million

Hence, correct answer is $ 6.25 million

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