Eisenhower Communications is trying to estimate the first-year net operating cas
ID: 2762554 • Letter: E
Question
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 11%.
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 $0.5 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 -Select-increasedecreaseItem 3 by $
Explanation / Answer
a)
Sales
$5,000,000.00
Less: Operating Cost
$3,500,000.00
Less: Depreciation
$1,000,000.00
EBIT
$500,000.00
Interest
$1,000,000.00
EBT
-$500,000.00
Less: Tax @40%
-$200,000.00
Net Income
-$300,000.00
Add: Depreciation
$1,000,000.00
OCF
$700,000.00
Note: If a firm makes loss in any particular year, it can adjust the loss next year’s income statement, which will reduce the taxes. So, this can be treated as a positive cash flow for the current year.
b)
Sales
$5,000,000.00
Less: Operating Cost
$3,500,000.00
Less: Depreciation
$1,000,000.00
EBIT
$500,000.00
Interest
$1,000,000.00
EBT
-$500,000.00
Less: Tax @35%
-$175,000.00
Net Income
-$325,000.00
Add: Depreciation
$1,000,000.00
OCF
$675,000.00
If tax rate drops, it will impact negatively in case of loss. So, this change will decrease the OCF by $25,000 ($700,000 - $675,000)
Sales
$5,000,000.00
Less: Operating Cost
$3,500,000.00
Less: Depreciation
$1,000,000.00
EBIT
$500,000.00
Interest
$1,000,000.00
EBT
-$500,000.00
Less: Tax @40%
-$200,000.00
Net Income
-$300,000.00
Add: Depreciation
$1,000,000.00
OCF
$700,000.00
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