Question

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?

Answer 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

= 898,000

Therefore, Free cash flow is $898,000