Question

Oxygen Optimization is considering the caffeine project, which would involve selling caffeinated oxygen for 1 year. The firm expects sales of caffeinated oxygen to be 64,000 dollars and associated costs from providing caffeinated oxygen (such as tanks, filters, etc.) to be 34,000 dollars. The firm believes that sales of regular oxygen, which is currently sold by the firm, would be 36,000 dollars less with the addition of caffeinated oxygen, and that costs associated with regular oxygen to be 27,000 less with the addition of the caffeinated oxygen. Finally, Oxygen Optimization believes that the introduction of caffeinated oxygen would increase traffic to its facilities, which would increase expected sales of other products (such as masks) by 28,500 dollars more than it would be without the addition of caffeinated oxygen, and increase costs by 7,000 more than it would be without the addition of caffeinated oxygen. What is the operating cash flow (OCF) for year 1 that Oxygen Optimization should use to analyze the caffeine project? The tax rate is 20 percent and the cost of capital is 17.69 percent. Relevant depreciation is expected to be 8,000 dollars.

Answer 1

Dear Student,

The question specifically asks for the operating cash flow to consider while calculating the NPV of the project.

Solution :

Particulars	Calculation	Amount	Remarks
Revenue	-	64000
Less: Expenses	-	(34000)
Less: Opportunity Cost of sale of regular oxygen	36000-27000	(9000)	Net of expenses
Add: Increase sale - Masks	28500-7000	21500	Net of expenses
Less : Depreciation	-	(8000)
Profit before tax		34500
Less: Tax	20% * 34500	(6900)
Profit After Tax		27600
Add:Depreciation		8000	Non-cash expenses are added back
Operating Cash flow		35600

Present Value of the cashflow to be considered in NPV calculation = 35600/1.1769

                                                                                                           = 30248.96

Hope you understand the solution.

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