Spartan Stores is expanding operations with the introduction of a new distribution center. Not only will sales increase but investment in inventory will decline due to increased efficiencies in getting inventory to showrooms. As a result of this new distribution center, Spartan expects a change in EBIT of $900,000. Although inventory is expected to drop from $87,000 to $62,000, accounts receivables are expected to climb as a result of increased credit sales from $89,000 to $180,000. In addition, accounts payable are expected to increase from $65,000 to $86,000. This project will also produce $250,000 of bonus depreciation in year 1 and Spartan Stores is in the 33 percent marginal tax rate. What is the project's free cash flow in year 1?
Calculate free cash flows as follows:
Free cash flow = EBIT [ 1- Tax] + Depreciation - Change in net working capital - Capital expenditure
= 900,000 [ 1- 0.33] + 250,000 - ( -45,000)
= 900,000 [ 0.67 ] + 250,000 + 45,000
= 603,000 +250,000 +45,000
Therefore, Free cash flow is $898,000
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