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Fairfax Paint operates stores in Virginia. The firm is evaluating the Vienna project, which would involve...

Fairfax Paint operates stores in Virginia. The firm is evaluating the Vienna project, which would involve opening a new store in Vienna. During year 1, Fairfax Paint would have total revenue of 357,000 dollars and total costs of 215,000 dollars if it pursues the Vienna project, and the firm would have total revenue of 298,000 dollars and total costs of 182,000 if it does not pursue the Vienna project. Depreciation taken by the firm would be 60,000 dollars if the firm pursues the project and 28,000 dollars if the firm does not pursue the project. The tax rate is 25 percent. What is the relevant operating cash flow (OCF) for year 1 of the Vienna project that Fairfax Paint should use in its NPV analysis of the Vienna project?

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Expert Solution

Ans) The operating cash flow ( OCF) as the name itself suggest is the cash generated by the business by the process of operation. It is very important for a business to have a positive operating cash flow as it helps a company to have sufficient liquidity to meet the expenses occuring without taking external financial assistance. The formula for operating cashflow is as follows : OCF ( operating cash flow) = Revenue - cost + Depreciation-Taxes if there is no working capital changes. The OCF is also use for the purpose of calculating the NPV or net present value of a project which is done to calculate effectively whether a project is undertaken or to take a decision regarding capital expenditure like purchase of machinery. Here fairfax Paint have to decide to open a store in Vienna. Revenue from Vienna project is

as follows : ( 357000- 298000 = 59000 ) as the revenue of fairfax paint + Vienna store = 357000 and revenue without Vienna store is 298000. Similarly cost of Vienna project = 215000-182000 = 33000.

Also depreciation of Vienna project = Depreciation of fairfax stores in Virginia + Vienna - Depreciation of fairfox stores in Virginia = 60000-28000 = 32000.

OCF = Revenue -cost +depreciation - Tax

hence OCF = 59000 -33000+32000 -14500 = $ 43500    here 59000-33000+32000 = 58000

Tax = 25% 0f 58000 = 14500)


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