Question

ABC is considering the launch of an ad campaign. It plans to spend $5.0 million on TV advertising. The ads are expected to increase sales by $9 million this year and $7 million next year. The new consumers are also expected to boost sales of other products by $2 million each year. ABC’s gross margin is 25% and average corporate tax rate is 35%. ABC needs to invest 10% of sales in NWC.

Estimate ABC’s FCF in year 1 is _______ and year 2 is _______ .

Answer 1

Ans:FCF IS nET OPERATING OPERATING AFTER TAX- INVESTMENT DURING PERIOD

FCF IN YEAR 1 IS:

Increased in sales = $ 9 million + $ 2 million

Gross margin = 25% *$ 11 million

= $ 2.75

Net profit = 2.75 * (1-.35) = $ 1.7875

FCF= $ 1.7875 - $ 1.1 MILLION* = -.6875MILLION

* 1.1 = 10% OF $11 SALES

FCF IN YEAR 2 IS:      

Increased in sales = $ 7 million + $ 2 million

Gross margin = 25% *$ 9million

= $ 2.25 MILLION

Net profit = 2.25 * (1-.35) = $ 1.4625

FCF= $ 1.4625 - $ 0.9 MILLION* = -.5625MILLION

* 0.9 = 10% OF $9 SALES