FIN/370 Finance for Business
January 13, 2013
Caledonia Products Integrative Problem
The following observation will describe the decisions made by a financial analyst who is working for the capital budget department at Caledonia Products. The organization has asked Team B to evaluate the potential risk involved in an upcoming transaction and identify several options in how to proceed. Because this is the team’s first assignments dealing with risk analyzes the team has been ask to further explain the details. The organization analysis will focus on free cash flows, projection of cash flows, projects initial outlay, cash flow diagram, net present value, internal rate of return, and if the project should be accepted.
Why focus on project free cash flows
Team B believes that Caledonia should focus on the project’s free cash flows and not the accounting profits. Evidence exists that the accounting profits will be earned by the project because there is a positive cash flow to the shareholders. With any investment there is the expectation that there will be an increase to the firm’s cash flow. Free cash flow is the total cash available to creditors who have invested their monies to finance the project. Accounting profits includes costs such as depreciation, interest, and taxes to run a business therefore it should not affect free cash flows. The project free cash flows range from year zero to year five and illustrate how much Caledonia Products will benefit if they choose to take on this project.
Projection of project in years one through five
There is annual working capital requirement of $100,000 to initiate the project. The incremental cash flows for the project in years one through five shows increase. For each year, the total investment in net working capital will be equal to 10% of the dollar value of sales for that year. In year one free cash flow is $2,100,000 in year two $3,600,000, which means...