April 1st, 2013
1. Why should Caledonia focus on project free cash flows as opposed to the accounting profits earned by the project when analyzing whether to undertake the project? Caledonia should observe the free cash flows on the project instead of the accounting profits because free cash flows help show how well the project can pay back its initial investment. Of course it will also show the projected profit of the project yearly as well. The accounting profits do not show just cash flow, but instead consider things like deprecation which is not cash and therefore it understates the amount of cash available (Titman, Keown, & Martin, 2011).
2. What are the incremental cash flows for the project in years 1 through 5 and how do these cash flows differ from accounting profits or earnings? Free cash flows differ from accounting profits because they incorporate depreciation back into the equation. It is important to add back in the depreciation expense, since the item was actually purchased using cash previously and depreciation is not a cash-flow (Titman, Keown, & Martin, 2011). Free cash flows also look at the Capital Expenditures (CAPEX) and Working Capital. The CAPEX includes initial project investments and also if there is any salvage value left on equipment. The Working Capital depends on how much the firm depended on credit and how much inventory they use as well.
3. What is the project’s initial outlay
The intial outlay is 8,000,000 (7,900,000 for new plant and equipment and 100,000 for shipping).
4. Sketch out a cash flow diagram for this project.
| |Year 0 |Year 1 |Year 2 |Year 3 |Year 4 |Year 5 | |Unit Price | |$300.00 |$300.00...