Question

Elmdale Enterprises is deciding whether to expand its production facilities. Although​ long-term cash flows are difficult to​ estimate, management has projected the following cash flows for the first two years​ (in millions of​ dollars):

	Year 1	Year 2
Revenues	128.9	151.7
COGS and Operating Expenses​ (other than​ depreciation)	34.5	55.1
Depreciation	26.7	43.1
Increase in Net Working Capital	2.4	8.5
Capital Expenditures	32.9	41.2
Marginal Corporate Tax Rate	35​%	35​%

a. What are the incremental earnings for this project for years 1 and​ 2?​ (Note: Assume any incremental cost of goods sold is included as part of operating​ expenses.)

b. What are the free cash flows for this project for years 1 and​ 2?

Answer 1

a). Calculating the Incremental Earnings for this project for years 1 and 2 (in millions of​ dollars):-

Particular	Year 1	Year 2
Revenue	128.9	151.7
Less: COGS and Operating Expenses	(34.5)	(55.1)
Less: Depreciation	(26.7)	(43.1)
EBIT	67.7	53.5
Less:Marginal Corporate Tax Rate @35%	(23.695)	(18.725)
Net Incremental earnings	44.005	34.775

b). Calculating the Free Cash flows for the project for years 1 and years 2:-

Free Cash flow from Firm = EBIT(1-Tax rate) + Depreciation - Change in Net Working Capital - Net Capital Spending

Project's year 1:-

FCF = 67.7(1-0.35) + 26.7 - 2.4 -32.9

FCF = $ 35.405 millions

Project's year 2:-

FCF = 53.5(1-0.35) + 43.1 - 8.5 -41.2

FCF = $ 28.175 millions

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