Pappy’s potato has come up with a new product, the Potato Pet. Pappy’s paid $120

Question

Pappy’s potato has come up with a new product, the Potato Pet. Pappy’s paid $120,000 for a marketing survey to determine the viability of the product. It is estimated that Potato Pet will generate sales of $650,000 per year. The fixed costs associated with this project will $200,000 per year and variable costs will amount to 20% of sales. The equipment will cost $540,000 and be depreciated in straight-line manner for 6 years, but the life of the new project is only 4 years. The equipment can be sold for $200,000 at the end of the project. The initial net working capital is $40,000 and will increase by $10,000 each year until the end of the project. Pappy’s is paying 40% tax rate and has a required rate of return of 13%.

Need help finding CFFA.

Explanation / Answer

CFFA (Cash Flow From Assets) indicates the cash flows generated by the firm's assets. CFFA also called as the Cash Flow of the Firm.

The categorization of cash flows are listed below.

·        Operating Cash Flow,

Operating Cash Flow = EBIT + Depreciation – Taxes

= [($650,000 - $200,000 – ($650,000*0.20)] + [($540,000-$200,000) / 4] – 40%

= $192,405

·        Capital Spending,

Capital Spending = Ending Net Fixed Assets- beginning Net Fixed Assets + Depreciation

($540,000-$85,000) - $540,000 + $85,000

= $0 in the present case.

·        Additions to Net Working Capital = Ending NWC – Beginning NWC

= [$40,000 + ($10,000*4)] -$40,000

= $40,000.

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