   Chapter 12, Problem 2P Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

Solutions

Chapter
Section Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

PROJECT CASH FLOW Eisenhower Communications is trying to estimate the first-year cash flow (at Year 1) for a proposed project The financial staff has collected the following information on the project: Sales revenues $10 million Operating costs (excluding depreciation) 7 million Depreciation 2 million Interest expense 2 million The company has a 40% tax rate, and its WACC is 10%. a. What is the project's cash flow for the first year (t = 1)? b. If this project would cannibalize other projects by$1 million of cash flow before taxes per year, how would this change your answer to Part a? c. Ignore Part b. If the tax rate dropped to 30%, how would that change your answer to Part a?

a.

Summary Introduction

To compute: The project’s cash flow for the first year.

Project’s Cash Flows:

Cash flow statement is prepared to see the position of cash. The cash flow for the specific project is known as the project cash flow.

Explanation

Given,

Sales revenue is $10 million. Operating cost excluding depreciation is$7 million.

Depreciation is $2 million. Interest expense is$2 million.

Tax rate is 40%.

The formula to calculate the first year cash flow is,

Cash flow for first year=[Earning before interst and taxes×(1Taxrate)+Depreciation]

Substitute $1 million for EBIT, 40% for tax rate and$2million for depreciation.

Cash flow for first year=$1million×(10.40)+$2million=$1million×(0.60)+$2million=$0 b. Summary Introduction To compute: The cash flow of project when the cash flow before tax is$1million.

c.

Summary Introduction

To compute: The project’s cash flow for the first year if the tax rate is 30%.

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