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 10%.

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.
   Would the firm's operating cash flow increase or decrease by $ ________

Answer 1

a.
Calculation of project's operating cash flow for first year
Sales revenue	$5,000,000
Less: Operating costs	$3,500,000
Less: Depreciation	$1,000,000
Income before taxes	$500,000
Taxes @ 40%	-$200,000
Net income	$300,000
Add: Depreciation	$1,000,000
Operating cash flow	$1,300,000
b.
Calculation of revised operating cash flow
Revised operating cash flow	1300000-(500000*(1-0.40))
Revised operating cash flow	1300000-300000
Revised operating cash flow	$1,000,000
c.
Calculation of impact on operating cash flow if tax rate falls to 30%
Calculation of project's operating cash flow for first year
Sales revenue	$5,000,000
Less: Operating costs	$3,500,000
Less: Depreciation	$1,000,000
Income before taxes	$500,000
Taxes @ 30%	-$150,000
Net income	$350,000
Add: Depreciation	$1,000,000
Operating cash flow	$1,350,000
Increase in operating cash flow	1350000-1300000
Increase in operating cash flow	$50,000