Ky Communications is trying to estimate the first-year cash flow (at Year 1) for

Question

Ky 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 revenue $15.0 million Operating Costs (excluding depreciation) $10.5 million Depreciation $03.0 million Interest Expense $03.0 million The company has a 40% tax rate, and its WACC is 11%. a. What is the project’s cash flow for the first year? b. If this project would cannibalize other projects by $1.5 million of cash flow before taxes per year, how would this change your answer to part a? c. Ignore part b. If the tax rate dropped to 30%, how would that change your answer to part a?

Explanation / Answer

Part A

Year 1 cash flow = (revenue – costs) x (1- tax rate) + Depreciation x tax rate

                            = (15 million – 10.50 million) x (1 -0.40) + 3 million x 0.40

                             = 2.70 million + 1.20 million

                             = 3.90 million

Part B

After tax cannibalization expense would be subtracted from existing OCF.

OCF = 3.90 million – 1.50 million x (1-0.40)

         = 3 million

Part C

Year 1 cash flow = (revenue – costs) x (1- tax rate) + Depreciation x tax rate

                            = (15 million – 10.50 million) x (1 -0.30) + 3 million x 0.30

                             = 3.15 million + .90 million

                             = 4.05 million

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