A firm is considering the purchase of a machine to produce tin cans, which would

Question

A firm is considering the purchase of a machine to produce tin cans, which would represent an investment of $21 million, and would be depreciated in a straight line basis over 5 years. Sales are expected to be $15 million per year, and operating costs 37% of sales. The company is currently paying $1 million in interest per year, has a tax rate of 40%, and a WACC of 10%. What is the company's free cash flow for year 1 of this project? (How to solve this, step by step please, and if it can be done in excel)

Explanation / Answer

Free cash flows for the project means cash flows available to long term debt holders( i.e. Shareholders and debt holders )after dedcting operating cost ,tax and other project expenses.Therefore, Formual for computing free cash flows for the project = EBIT(1-Tax Rate) + Depreciation & Amortization - Change in Net Working Capital - Capital Expenditure.

Free cash flow for the year 1 of the project

Note: Depreciation p.a =21/5 =$ 4.2 million

Depreciation has to be deducted from the sales because because it is an expenditure and it should be added back to PBIT as it is not a cash expenditure.

Year 1 Type of cash flows Million($) Sales Inflow 15 Operating cost Outflow 5.55 Depreciation Non -cash expenses 4.2 PBIT Inflow 5.25 Less: tax@40% Outflow 2.1 Add: Depreciation Non -cash expenses 4.2 Free cash flows inflow 7.35

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