Question

You are considering creating a new product line in warehouse space that originally cost you $52,895 5 years ago.  

The required machinery would cost $6,786, should last 9 years, after which could be scrapped for $887.
Net working capital would need to immediately increase by $4,332, but could return to normal levels after 9 years.
Annual sales and operating costs are expected to be $7,097 and $1,688, respectively.
18% of customers are expected to switch over from your existing product lines.
Your firm's cost of capital (WACC) is 8.3% and effective corporate tax rate is 43%.
Your firm uses straight line depreciation as its depreciation method.
What is this project's incremental cash flow in its final year 9?

Answer 1

A1	B	C	D	E	F	G	H	I	J	K
2
3
4		Free cash flow can be calculated as follows:
5		Free Cash Flow = Operating Cash Flow - Capital Expenditures - Change in working capital
6		Operating Cash Flow = EBIT*(1-Tax Rate)+Depreciation
7		Tax Rate	43%
8		Amount spent on warehouse space is an opportunity cost.
9		Opportunity cost for warehouse space	52,895
10		Life of the project	9	years
11		Immediate investment in Machinery	$6,786
12		Initial investment in working capital	$4,332
13
14
15		Depreciation each year can be calculated as follows:
16		Machine Cost	$6,786
17		Life of Machine	9	years
18		Salvage value	887
19		Depreciation per year	=(Investment - Salvage Value)/Expected life of equipment
20			$655	=(D16-D18)/D17
21
22		Hence depreciation each year can be calculated as follows:
23				Year 1	Year 2	Year 3	…	9
24		Depreciation (B*rt)		$655	$655	$655	$655	$655
25		Book Value	$6,786	$6,131	$5,475	$4,820	$4,164	$887
26
27		Net Proceed from sale calculation:
28		Market Value at the end of 9th year	$887
29		Book Value of machine at the end of 9th year	$887
30		Gain or Loss on sale of Machine	=Proceed From Sale - Book value at the end of sale
31			$0
32
33		Gain or Loss on sale of Machine	$0
34		Tax on Gain & Loss	$0.00
35		Net Proceed from Sale of Machine	=Proceed from Sale - Tax Expense on gain or loss
36			$887	=D28-D34
37
38		Free cash Flow calculation:
39		Free cash flow can be calculated as followed:
40		Year	0	1	2	3	…	9
41		Revenue		$7,097	$7,097	$7,097	$7,097	$7,097
42		Operating Expense		($1,688)	($1,688)	($1,688)	($1,688)	($1,688)
43		Depreciation		($655)	($655)	($655)	($655)	($655)	=-$D$20
44		Operating Income Before Tax (EBIT)		$4,754	$4,754	$4,754	$4,754	$4,754	=SUM(I41:I43)
45		Tax (@43%)		($2,044)	($2,044)	($2,044)	($2,044)	($2,044)	=-I44*$D$7
46		After Tax operating income (EBIT*(1-T))		$2,710	$2,710	$2,710	$2,710	$2,710	=I44+I45
47		Add Depreciation		$655	$655	$655	$655	$655	=-I43
48		Operating Cash Flow		$3,365	$3,365	$3,365	$3,365	$3,365	=I46+I47
49		Opportunity Cost	($52,895)
50		Initial investment	($6,786)
51		Investment in Working Capital	($4,332)	$0	$0	$0	$0	$4,332	=-D51
52		Net Proceed from Sale of Equipment						$887	=D36
53		Free Cash Flow	($11,118)	$3,365	$3,365	$3,365	$3,365	$8,584	=SUM(I48:I52)
54
55		Hence incremental cash flow in year 9 is	$8,584
56

Formula sheet