Question

Enterprises is deciding whether to expand its production facilities. Although long-term cash flows are difficult to...

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 first two years:

year 1 year 2

Revenue $127.7 $169.3

COGS and operating Expenses (other than depreciation) $ 39.2 $ 64.4

Depreciation $ 22.7 $ 37.9

Increase in Net working capital $ 2.2 $ 7.7

Capital Expenditures $ 30.7 $ 41.3

Marginal Corporate Tax rate 35% 35%

a. What are the incremental earnings for this project for years 1 and 2?

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

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

Calculate the incremental earnings of this project below:

Incremental Earnings Forecast Year 1

Sales

Operating Expenses

Depreciation

EBIT

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Homework Answers

Answer #1
Year Year 1(in USD) Year 2(in USD)
Sales 127.7 169.3
Less: Operating Expenses (39.2) (64.4)
Operating Profit 88.5 104.9
Less: Depriciation (22.7) (37.9)
EBIT 65.8 67
Less: Tax (23.03) (23.45)
Earnings After Tax 42.77 43.55

a) Incremental Earnings = (Earnings After Tax)t - (Earnings After Tax)t-1

Incremantal Earnings for year 1 = 42.77 - 0 = 42.77 USD

Incremental Earnings for year 2 = 43.55 - 42.77 = 0.78 USD

The incremental earnings for year 1 and year 2 are 42.77 USD and 0.78 USD

b) Free cash flow = Earnings after Tax + Depreciation + Interest - Increase in Working capital - Incresae in Capital Expenditure

Free cash flow for year 1 = 42.77 + 22.7 - 2.2 - 30.77 = 32.5 USD

Free cash flow for year 2 = 43.55 + 37.9 - 7.7 - 41.3 = 31.99 USD

Hence, Free Cash flow for year 1 and year 2 are 32.5 USD and 31.99 USD

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