Question

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 11%.

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

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

b-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 $ .

c- 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 $ .

Answer 1

a).

Particulars	Amount($)
Sales	25,000,000
Less: Operating Costs	17,500,000
Less: Depreciation	5,000,000
Operating Income Before Taxes	2,500,000
Less: Tax Expense(40%)	1,000,000
Operating Income After Taxes	1,500,000
Add: Depreciation	5,000,000
Operating Cash Flow	6,500,000

b). If the project is cannibalizing other areas of the company, then that money has to be taken

away from the operating cash flow of the project. However, everything we do in this class is

after tax, so the $2 million needs to be reduced from the operating cash flow after tax.

New Operating Cash Flow = $6,500,000 - [$2,500,000(1 - 0.40)]

= $6,500,000 - $1,000,000 = $5,500,000

c).

Particulars	Amount($)
Operating Income Before Taxes	2,500,000
Less: Tax Expense(@30%)	750,000
Operating Income After Taxes	1,750,000
Add: Depreciation	5,000,000
Operating Cash Flows	6,750,000

Thus, the project’s cash flow would increase by $250,000.