Solution to Integrative problems

1. We focus on free cash flows rather than accounting profits because these are the flows that the firm receives and can reinvest. Only by examining cash flows are we able to correctly analyze the timing of the benefit or cost. Also, we are only interested in these cash flows on an after tax basis as only those flows are available to the shareholder. In addition, it is only the incremental cash flows that interest us, because, looking at the project from the point of the company as a whole, the incremental cash flows are the marginal benefits from the project and, as such, are the increased value to the firm from accepting the project.

2. Although depreciation is not a cash flow item, it does affect the level of the differential cash flows over the project's life because of its effect on taxes. Depreciation is an expense item and, the more depreciation incurred, the larger are expenses. Thus, accounting profits become lower and in turn, so do taxes which are a cash flow item.

3. When evaluating a capital budgeting proposal, sunk costs are ignored. We are interested in only the incremental after-tax cash flows, or free cash flows, to the company as a whole. Regardless of the decision made on the investment at hand, the sunk costs will have already occurred, which means these are not incremental cash flows. Hence, they are irrelevant.

Solution to Integrative Problem, parts 4, 5, & 6.

Section I. Calculate the change in EBIT, Taxes, and Depreciation (this become an input in the calculation of Operating Cash Flow in Section II).

Year
Units Sold		70,000	120,000	140,000	80,000	60,000
Sale Price		$300	$300	$300	$300	$260
Sales Revenue		$21,000,000	$36,000,000	$42,000,000	$24,000,000	$15,600,000
Less: Variable Costs		12,600,000	21,600,000	25,200,000	14,400,000	10,800,000
Less: Fixed Costs		$200,000	$200,000	$200,000	$200,000	$200,000
Equals: EBDIT		$8,200,000	$14,200,000	$16,600,000	$9,400,000	$4,600,000
Less: Depreciation		$1,600,000	$1,600,000	$1,600,000	$1,600,000	$1,600,000
Equals: EBIT		$6,600,000	$12,600,000	$15,000,000	$7,800,000	$3,000,000
Taxes (@34%)		$2,244,000	$4,284,000	$5,100,000	$2,652,000	$1,020,000

Section II. Calculate Operating Cash Flow (this becomes an input in the calculation of Free Cash Flow in Section IV).

Operating Cash Flow:
EBIT		$6,600,000	$12,600,000	$15,000,000	$7,800,000	$3,000,000
Minus: Taxes		$2,244,000	$4,284,000	$5,100,000	$2,652,000	$1,020,000
Plus: Depreciation		$1,600,000	$1,600,000	$1,600,000	$1,600,000	$1,600,000
Equals: Operating Cash Flow		$5,956,000	$9,916,000	$11,500,000	$6,748,000	$3,580,000

Section III. Calculate the Net Working Capital (This becomes an input in the calculation of Free Cash Flows in Section IV).

Change In Net Working Capital:
Revenue:		$21,000,000	$36,000,000	$42,000,000	$24,000,000	$15,600,000
Initial Working Capital Requirement	$100,000
Net Working Capital Needs:		$2,100,000	$3,600,000	$4,200,000	$2,400,000	$1,560,000
Liquidation of Working Capital						$1,560,000
Change in Working Capital:	$100,000	$2,000,000	$1,500,000	$600,000	($1,800,000)	($2,400,000)

Дата добавления: 2015-10-30