Question

Expansion Project

CapEx at t=0: $180,000

Inventories will rise by $25,000 and payables will rise by $5,000.

MACRS 1-year class property (depreciation: year 1 - 55%, year 2 - 45%)

Economic life: 2 years

Salvage value: $40,000

Annual sales revenue: $350,000

Operating costs: 60% of sales

Tax rate: 40%

Inflation: 0%

Calculate t=0 OCF

Calculate t=0 FCF.

Calculate t=1 OCF.

Calculate t=1 FCF.

Calculate t=2 OCF.

Calculate t=2 FCF.

Answer 1

Answers: -

t=0 OCF = $0

t=0 FCF = ($200,000)

t=1 OCF = $123,600

t=1 FCF =$123,600

t=2 OCF = $116,400

t=2 FCF = $160,400

Explanation: -

Step 1: calculation of Operating cash flows:

Depreciation calculations:

Depreciation expense of Year 1 = $180,000 * 55% = $99,000

Depreciation expense of Year 2 = $180,000 * 45% = $81,000

Years	0	1	2
Sales revenue	0	350,000	350,000
Operating costs (60% of revenue)	0	(210,000)	(210,000)
Depreciation (y1=55%,y2=45%)	0	(99,000)	(81,000)
Operating income	0	41,000	59,000
Tax (40%)	0	(16,400)	(23,600)
Net income	0	24,600	35,400
ADD non cash item( depreciation)	0	99,000	81,000
Operating cash flow	0	123,600	116,400

Step 2: calculating of free cash flow

Calculation of Net incremental working capital

Net incremental working capital = increase in inventories – increase in payables

= $25,000 - $5,000

= $10,000

Calculation of Net cash flow from salvage

Since there the asset is fully depreciated the book value is zero, therefore

Net cash flow from salvage = salvage value * (1-tax rate)

= $40000 * (1-.4)

= $24,000

Since there the asset is fully depreciated the book value is zero

Years	0	1	2
initial capital expense	($180,000)
Net working capital	-20000		20000
Operating cash flow	0	123600	116400
salvage cash flow			24,000
Free cash flow	($200,000)	$123,600	$160,400