Question

Colsen 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:

Sales revenues	$5 million
Operating costs (excluding depreciation)	3.5 million
Depreciation	1 million
Interest expense	1 million

The company has a 40% tax rate, and its WACC is 13%.

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

1. What is the project's operating cash flow for the first year (t = 1)? Round your answer to the nearest dollar.
   $  
2. 
   
3. 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 dollar.
   The firm's OCF would now be $  
4. 
   
5. 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 operating cash flow would -Select-increase/decrease by $  

Answer 1

Answer to Part b.

The cannibalization of existing sales needs to be considered in this analysis on an after-tax basis, because the cannibalized sales represent sales revenue the firm would realize without the new project but would lose if the new project is accepted.

Thus, the after-tax effect would be to reduce the firm’s operating cash flow by
$1,000,000(1– T) = $1,000,000(0.6) = $600,000.

Thus, the firm’s OCF would now be $2,000,000 rather than $2,600,000.

The firm's operating cash flow would increase by $50,000.