Question

What are the annual cash flow from operations in years 1,2 and 3 ?

Compute the after tax salvage value in year 3?

What are the free cash flows in years 0,1,2, and 3 (also consider NWC) ?

Question 17 4pts Use the following information to answers questions 17 to 26. (Long Answer/Essay - primarily Chapter 13 but includes concept from many chapters) You are the CFO of Micro Spinoff Inc. The company has 3,000,000 shares of common stock outstanding ata market price of $50 a share. Micro Spinoff just paid an annual dividend in the amount of $3.12 per share. The dividend growth rate is 5.8 percent annually. Micro Spinoff also has 70,000 bonds outstanding with a face value of $1.000 per bond that are selling at 115.372 percent of par. The bonds have a 12 percent coupon pay interest semiannually, and have 15 years to maturity. Finally the firm has 400,000 shares of preferred stock outstanding at a market price of $58.48 a share. Preferred stock padded of 6.67 percent on its par value of $75.00. The firm is considering a three-year expansion oject (same operations as the existing projects of the firm that requires an initia investment in a machine of $200,000. The increase in Net Working Capital (WC) at time is $10,000 that will be reduced to normal levels at the end of the project at time 3. The machine has a life of as and will be depreciated to using method. The Eamings Before Interest, Taxes. Depreciation and Anotation EBITDA in the first year is $70.000 and the w ro at 6 percent a year. At the end of the project (year 31. the machine can be sold for $10.000. The firm's tax rate is 21 percent

Answer 1

Solution to question 1

Depreciation in straight-line method = Cost of purchase - salvage value/depreciable life

= $200,000/4 = $50,000

net income = EBITDA - depreciation - tax

tax = tax rate * ( EBITDA - depreciation)

cash flow from operation = net income + non-cash items (depreciation)

Net income for year 1 = $70,000 - $50,000 - [0.21 * ( $70,000-$50,000)] = $20,000 - (0.21 * $20,000)

=$20,000 - $4,200 = $15,800

cash flow from operation in year 1 = $15,800 + $50,000 = $65,800

Net income for year 2 = ($70,000*1.06) - $50,000 - [0.21 * {( $70,000*1.06) - $50,000)}] = $74,200 - $50,000 - [0.21 * ( $74,200-$50,000)]

= $24,200 - (0.21 * $24,200)

=$24,200 - $5,082 = $19,118

cash flow from operation in year 2 = $19,118 + $50,000 = $69,118

Similarly,

Net income for year 3 = ($74,200*1.06) - $50,000 - [0.21 * {( $74,200*1.06) - $50,000)}] = $78,652 - $50,000 - [0.21 * ( $78,652 - $50,000)]

= $28,652 - (0.21 * $28,652)

= $28,652 - $6,016.92 = $22,635.08

cash flow from operation in year 3 = $22,635.08 + $50,000 = $72,635.08

Solution to question 2

Salvage value at the end of year 3 was $10,000

tax on sale of machine = tax rate * (salvage value - book value)

book value at the end of year 3 = cost of equipment - depreciation for 3 years = $200,000 - 3* $50,000 = $50,000

There will be a tax refund because book value is higher than salvage value

Tax refund = tax rate * (book value - salvage value) = 0.21 * ($50,000 - $10,000) = 0.21* $40,000 = $8,400

after-tax salvage value = salvage value + tax refund = $10,000 + $8,400 = $18,400

Solution for question 3

Free cash flow for year 1 = $65,800 as calculated above

free cash flow for year 2 = $69,118 as calculated above

free cash flow for year 3 = cash flow from operations in year 3 + after-tax salvage value + recapture of net working capital

= $72,635.08 + $18,400 + $10,000 = $101,035.08