Question

HW15-5)

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 99,000 dollars and associated costs from providing caffeinated oxygen (such as tanks, filters, etc.) to be 64,000 dollars. The firm believes that sales of regular oxygen, which is currently sold by the firm, would be 35,000 dollars less with the addition of caffeinated oxygen, and that costs associated with regular oxygen to be 28,000 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 20,500 dollars more than it would be without the addition of caffeinated oxygen, and increase costs by 13,000 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 12.9 percent. Relevant depreciation is expected to be 3,000 dollars.

Answer 1

Here, consider the sale due to the new product as the major cash inflow. However, due to the new product the change in other sale and expenses also needs to be considered. So, a reduction in sale of regular oxygen is subtracted, and cost/ expenses which we did not occur of 28000 is added back. I believe these steps re similar to the consideration of how change in working capital is considered in an ideal case calcuation.

We calculate similarly for other products where, increase in sale and expenses are added and subtracted respectively. Then, we calculate EBIT, post taking depreciation into consideration. (Remember, that depreciation is subtracted initially to help us reduce our tax exposure). Post calculation of Tax, to calculate the Cash flow, we add back the depreciation as its a non cash expense. So, OCF = EBIT + Depreciation - Tax.

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