Bus 401 - Principles of Finance - Final Project

Since it has been two months since the new Assistant Financial Analyst has taken the position with Caldeonia Products Company, the supervisor has been pleased with the Analyst work thus far. He would like to give additional responsibilities that will require no supervision but he is a bit hesitant. Therefore he assigns a project that will be able to prove if the new employee is ready for more responsibilities without any supervision. We will walk through each task, given the data provided, and provide a detail response. Upon completion of this task, we would hope that the supervisor is well pleased with the final project, therefore giving the Analyst a chance to advance within the company.

A. Should Caledonia focus on cash flows or accounting profits in making its capital-budgeting decisions? Should the company be interested in incremental cash flows, incremental profits, total free cash flows, or total profits?

Caledonia would benefit if they would concentrate on the cash flow because rather than the accounting profits. The incremental cash flow is definitely something the company should be interested. Canvassing the project shows us that the marginal benefit from the project with increased value to the company because they accepted the project. Reason being because the company can reinvest which a wonderful opportunity is for any company. Now looking at the cash flow an analysis can be made to accurately review the timing of the benefit. Again it would benefit the company to look upon the cash flow after-tax basis which is available to shareholders.

B. How does depreciation affect free cash flows?

Depreciation affects free cash flows because of its effects on taxes. The accounting profits is lowered which in turn, the taxes become a cash flow item. Depreciation is an expense meaning the more that the depreciation has incurred, then the expenses begin to grow larger.

C. How do sunk costs affect the determination of cash flows?

Considering the data provided for this case, we must evaluate the capital budget proposal which ignores the sunk costs. Something the company should be interested with is the incremental after-tax cash flows which would benefit the company as a whole. At this point it will not make a difference with the investment because the sunk cost will have occurred which means these are not the incremental cash flow.

Parts D,E & F ( Also see attached Excel Spreadsheet)

Year 0 1 2 3 4 5

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 $1,600,0000 $1,600,0000 $1,600,0000 $1,600,0000

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

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

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