Spartan Stores is expanding operations with the introduction of a new distributi

Question

Spartan Stores is expanding operations with the introduction of a new distribution center. Not only will sales increase, but investment in inventory will decline due to increased efficiencies in getting inventory to showrooms. As a result of this new distribution center, Spartan expects a change in EBIT of $900,000. While inventory is expected to drop from $90,000 to $70,000, accounts receivables are expected to climb as a result of increased credit sales from $80,000 to $110,000. In addition, accounts payable are expected to increase from $65,000 to $80,000. This project will also produce $300,000 of depreciation per year and Spartan Stores is in the 34 percent marginal tax rate. What is the project’s free cash flow in year 1?

Explanation / Answer

First we should look into what are the changes happend during the period of 2 years in current assets and liabilites : Free cash flow = EBIT *[1-Tax] Depreciation -changes in Net working capital - capital expenditure = $900000 *[1-0.34] 300000 - 10000 = $594000 300000-10000 = $884000 Note : Capital expenditure has not been specified.So it was left to considered. There is an error in the solution: In the current liabilities the figure should be 80000 for the second year. so changes in current liabilities is 15000. the correct answer is $889000

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