Eisenhower Communications is trying to estimate the first-yearnet operating cash

Question

Eisenhower Communications is trying to estimate the first-yearnet operating cash flow (at year 1) for a proposed project. Thefinancial staff has collected the following information on theproject:

Salesrevenues                                                                              $10million

Operating costs(excludingdepreciation)                                 7 million

Depreciation                                                                                      2 million

Interestexpense                                                                               2 million

The company has a 40 percent tax rate, and its WACC is 10percent.

a.   a.What is the project’s operating cashflow for the first year (t=1)?

b.   b.If this project would cannibalize otherprojects by $1 million of cash flow before taxes per year, howwould this change your answer to part a?

c.   c.Ignore part b. If the tax ratedropped to 30 percent, how would that change your answer to parta?

Explanation / Answer

(a) Calculating Operating Cash flow for thefirst year (t=1) Sales Revenue $10,000,000.00 Less: Operating Expenses $7,000,000.00         Depreciation $2,000,000.00 $9,000,000.00 Earnings Before Interest and Taxes(EBIT) $1,000,000.00 Operating Cash flow = (EBIT + Depreciation) -Taxes Operating Cash flow = ($1,000,000 + $2,000,000) -$400,000 Operating Cash Flow = $2,600,000 (c ) Calculating Operating Cash flow, if the tax ratedropped to 30%: Operating Cash flow = ($1,000,000 + $2,000,000) -$300,000 Operating Cash Flow = $2,700,000 (b) Cannibalization Occurswhen a new Project leads to a Reduction in Sales of an existingProject. Sales ($10,000,000 - $1,000,000 = $9,000,000) Sales Revenue $9,000,000.00 Less: Operating Expenses $7,000,000.00         Depreciation $2,000,000.00 $9,000,000.00 Earnings Before Interest and Taxes (EBIT) $0.00 Operating Cash flow = (EBIT + Depreciation) -Taxes Operating Cash flow = ($0 + $2,000,000) -$400,000 Operating Cash Flow =$1,600,000 Hope it may help you (a) Calculating Operating Cash flow for thefirst year (t=1) Sales Revenue $10,000,000.00 Less: Operating Expenses $7,000,000.00         Depreciation $2,000,000.00 $9,000,000.00 Earnings Before Interest and Taxes(EBIT) $1,000,000.00 Operating Cash flow = (EBIT + Depreciation) -Taxes Operating Cash flow = ($1,000,000 + $2,000,000) -$400,000 Operating Cash Flow = $2,600,000 (c ) Calculating Operating Cash flow, if the tax ratedropped to 30%: Operating Cash flow = ($1,000,000 + $2,000,000) -$300,000 Operating Cash Flow = $2,700,000

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