Question

​(Calculating free cash flows​) Spartan Stores is expanding operations with the introduction of a new distribution center. Not only will sales increase but investment in inventory will decline due to increased efficiencies in getting inventory to showrooms. As a result of this new distribution​ center, Spartan expects a change in EBIT of ​$940,000. Although inventory is expected to drop from ​$82,000 to ​$64,000​, accounts receivables are expected to climb as a result of increased credit sales from ​$86,000 to ​$110,000. In​ addition, accounts payable are expected to increase from ​$65,000 to ​$84,000. This project will also produce ​$350,000 of bonus depreciation in year 1 and Spartan Stores is in the 32 percent marginal tax rate. What is the​ project's free cash flow in year​ 1?

Answer 1

Solution:-

Changes happened during the period of two years in current assets and current liabilities;

Particulars	Year 1	Year 2	Change
Inventory	$82,000	$64,000	$18,000
Acconts receivable	$86,000	$110,000	-$24,000
Current assets	$168,000	$174,000	-$6,000
Accounts payable	$65,000	$84,000	$19,000
Current liabilities	$65,000	$84,000	$19,000
Net working capital	103,000	$90,000	$13,000

Free cash flow = EBIT *(1-tax) + Depreciation - changes in net working capital - capital expenditure

= $940,000 * (1-32%) + $350,000 - $13,000 - 0

= $940,000 * 68% + $350,000 - $13,000

= $639,200 + $350,000 - $13,000

= $976,200

Therefore the project cash flow for year 1 of spartan stores is $976,200.