Question

you are the CFO of the Imaginary Products Co. the company provides the following information about its capital structure:

Debt: the firm has 200,00 bonds outstanding with a pair value of $1,000, pays 9 percent interest (semi- annual coupon payments), have a maturity of 15 years and have a quoted price of 137.55 per bond.

preferred shares: the firm also has an issue of 2 million preferred shares outstanding with a market price of $12.00 per share. the preferred shares pay an annual dividend of 2.4 percent of the par value of $50.00.

common stock: the company also has 14 million shares of common stock outstanding with a price of $20.00 per share. the firm is expected to pay a $2.20 common dividend one year from today, and that dividend is expected to increase by 5 percent per year forever.

the firm is considering a 3 year expansion project (same operations as the existing projects of the firm) that requires a purchase of a machine of $210,000. there will be an increase in inventory of $150,000, accounts receiveable of $35,000, and accounts payable of $75,000. the machine will be in the 3- year MARCS class and the annual depreciation rates are 33 percent in year 1, 44 percent in year 2, 15 percent in year 3, and 8 percent in year 4.

the project is expected to generate Earnings Before Interest, Taxes, Deprecation, and Amortization (EBITDA) of $80,000 each year. At the end of the project (year 3) the machine can be sold for $25,000. the firms tax rate is 21 percent.

what are the free cash flows in years 0,1,2, and 3?

Answer 1

Calculation of free cahs flows
Particulars	0	1	2	3
Initial Investment
Cost of Machine	-210000
Investement in net working capital ($150,000 + $35,000 - $$75,000)	-110000
Net Investment (A)	-320000
Operating Cash Flows
EBDITA (B)		80000	80000	80000
Depreciation (C ) $210,000 * 33%, 44% , 15%		69300	92400	31500
Profit Before Tax (D = B-C)		10700	-12400	48500
Tax @21% (E = D*21%)		2247	-2604	10185
Profit After Tax (F = D-E)		8453	-9796	38315
Add back Depreciaiton (G = C)		69300	92400	31500
Net Operating Cahs Flows (H = F+G)		77753	82604	69815
Terminal Value
Sale Value (I)				25000
Book value (J = $210,000 * 8%)				16800
Profit on sale (K = I-J)				8200
Tax on profit (L = K*21%)				1722
After tax sale value (M = I-L)				23278
Recovery of working capital (N)				110000
Net Terminal Value (O = M+N)				133278
Free Cash Flows (P = A+H+O)	-320000	77753	82604	203093
Free Cash Flow in Year 0 is -$320,000
Free Cash Flow in Year 1 is $77,753
Free Cash Flow in Year 2 is $82,604
Free Cash Flow in Year 3 is $203,093