Question

In: Finance

Colsen Communications is trying to estimate the first-year cash flow (at Year 1) for a proposed...

Colsen 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 revenues $25 million
Operating costs (excluding depreciation) 17.5 million
Depreciation 5 million
Interest expense 5 million

The company has a 40% tax rate, and its WACC is 14%.

Write out your answers completely. For example, 13 million should be entered as 13,000,000.

  1. What is the project's cash flow for the first year (t = 1)? Round your answer to the nearest dollar.
    $

  2. If this project would cannibalize other projects by $2.5 million of cash flow before taxes per year, how would this change your answer to part a? Round your answer to the nearest dollar.
    The firm's project's cash flow would now be $ .

  3. Ignore part b. If the tax rate dropped to 30%, how would that change your answer to part a? Round your answer to the nearest dollar.
    The firm's project's cash flow would -Select-increasedecreaseItem 3 by $ .

Solutions

Expert Solution

(a)-The project's operating cash flow for the first year (t = 1)

The project's operating cash flow for the first year = EBIT(1 – Tax rate) + Depreciation Expenses

= [(Sales Revenue – Operating Costs – Depreciation Expenses) x (1 – Tax rate)] + Depreciation Expenses

= [($25,000,000 - $17,500,000 - $5,000,000) x (1 – 0.40)] + $5,000,000

= [$2,500,000 x 0.60] + $5,000,000

= $1,500,000 + $5,000,000

= $6,500,000

The project's operating cash flow for the first year will be $6,500,000

(b)-Change in cash flow if this project would cannibalize other projects by $2.50 million of cash flow before taxes per year

If this project would cannibalize other projects by $2.50 million of cash flow before taxes per year, then the Operating cash flow would be reduced to the extent of after-tax amount cannibalized.

Therefore, the firm's new Operating cash flow (OCF) = Old project's operating cash flow – [Amount cannibalized x (1 – Tax rate)]

= $6,500,000 - [$2,500,000 x (1 – 0.40)]

= $6,500,000 - [$2,500,000 x 0.60]

= $6,500,000 - $1,500,000

= $5,000,000

Hence, the firm's OCF would now be $5,000,000

(c)-Change in firm's project's cash flow if the tax rate dropped to 30%

Operating cash flow = [(Sales Revenue – Operating Costs – Depreciation Expenses) x (1 – Tax rate)] + Depreciation Expenses

= [($25,000,000 - $17,500,000 - $5,000,000) x (1 – 0.30)] + $5,000,000

= [$2,500,000 x 0.70] + $5,000,000

= $1,750,000 + $5,000,000

= $6,750,000

Therefore, the Change in Operating cash flow = $6,750,000 - $6,500,000

= $250,000

Hence, the firm's project's cash flow would Increase by $250,000


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