Elmdale Enterprises is deciding whether to expand its production facilities. Although long-term cash

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) ( see MyFinanceLab for the data in Excel format ): 1 Year 1 2 2 Revenues 125 160 3 Operating Expenses (other than depreciation) 40 60 4 Depreciation 25 36 5 Increase in Net Working Capital 2 8 6 Capital Expenditures 30 40 7 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 the first two years?
Solution: a) Incremental earnings: Year 1 Year 2 Revenues 125 160 Operating Expenses (other than depreciation) 40 60 Depreciation 25 36 Profit before tax 60 64 Tax 21 22 Net earnings 39 42 b) Free cash flow: Year 1 Year 2 Revenues 125 160 Operating Expenses (other than depreciation) 40

60 Depreciation 25 36 Profit before tax 60 64 Tax 21 22 Net earnings 39 42 Add: Depreciation 25 36 Less: Increase in working capital 2 8 Less: Capital expenditure 30 40 FREE CASH FLOW 32 30

ANSWER:

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