Project cash flow Eisenhower Communications is trying to estimate the first-year

Question

Project cash flow

Eisenhower Communications is trying to estimate the first-year net operating cash flow (at Year 1) for a proposed project. The financial staff has collected the following information on the project:

The company has a 40% tax rate, and its WACC is 12%.

Write out your answers completely. For example, 13 million should be entered as 13,000,000.

What is the project's operating cash flow for the first year (t = 1)? Round your answer to the nearest cent.
$ ______

If this project would cannibalize other projects by $2.5 million of cash flow before taxes per year, how would this change your answer to part a? Round your answer to the nearest cent.
The firm's OCF 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 cent.
The firm's operating cash flow would increase or decrease Item by $ ____

Sales revenues $25 million Operating costs (excluding depreciation) 17.5 million Depreciation 5 million Interest expense 5 million

Explanation / Answer

Part 1

Part 2

The cannibalize sales is sales revenue the firm would realize without the new project but would loose if the new project gets accepted, thus cannibalization of existing sales needs to be considered in calculating the after -tax basis. The after tax would reduce the firm's operating cash flows. The decrease would be $2,500,000 x (1 - tax rate) = $2,500,000 x .06 = $1,500,000. Now the firms operating cash flow would be $6,500,000 - $1,500,000 = $5,000,000.

Part 3

When tax rate is dropped to 35% the firm's operating cash flow will increase by $6,625,000 - $6,500,000 = $125,000.

Hope this resolves your question.

Sales revenue $     25,000,000 Less: Operating costs (excluding depreciation) $     17,500,000 Depreciation $       5,000,000 Operating income before taxes $       2,500,000 Less : Taxes 2,500,000 x 40% $       1,000,000 Operting income after taxes = Operating income before taxes - taxes $       1,500,000 Add Back depreciation $       5,000,000 Operating cash flows $       6,500,000

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