Caledonia Problem
Caledonia Products Integrative Problem
July 31, 2013
Yvette “Betsy” Stewart
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?
It is important that Caledonia Company should focus on the free cash flows instead of the accounting profits. With the free cash flows that the company receives they can reinvest. To accurately analyze the timing of the benefit or cost we can examine the cash flows. The only cash flows that the company should be interested in are the after-tax basis because these are the flows that are available to shareholders. When we look at the company as a whole, that shows us how important the incremental cash flow is and that interests the company. These incremental cash flows are the marginal benefits from the project and since the firm accepts the project they are the increased value to the firm.
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?
21,000,000 36,000,000 42,000,000 24,000,000 15,600,000 Project Revenue
200,000 200,000 200,000 200,000 200,000 Minus fixed expenses
12,600,000 21,600,000 25,200,000 14,400,000 10,800,000 Minus variable expenses
8,200,000 14,200,000 16,600,000 9,400,000 4,600,000 Equals gross profit
1,600,000 1,600,000 1,600,000 1,600,000 1,600,000 Minus depreciation
6,600,000 12,600,000 15,000,000 7,800,000 3,000,000 Equals net operating income
2,244,000 4,284,000 5,100,000 2,652,000 1,020,000 Minus taxes (34%)
4,356,000 8,316,000 9,900,000 5,148,000 1,980,000 Equals net operating profit after taxes
$1,600,000 $1,600,000 $1,600,000 $1,600,000 $1,600,000 Plus depreciation
5,956,000 9,916,000 11,500,000 6,748,000 3,580,000 Equals operating cash flow
Taking away taxes from
July 31, 2013
Yvette “Betsy” Stewart
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?
It is important that Caledonia Company should focus on the free cash flows instead of the accounting profits. With the free cash flows that the company receives they can reinvest. To accurately analyze the timing of the benefit or cost we can examine the cash flows. The only cash flows that the company should be interested in are the after-tax basis because these are the flows that are available to shareholders. When we look at the company as a whole, that shows us how important the incremental cash flow is and that interests the company. These incremental cash flows are the marginal benefits from the project and since the firm accepts the project they are the increased value to the firm.
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?
21,000,000 36,000,000 42,000,000 24,000,000 15,600,000 Project Revenue
200,000 200,000 200,000 200,000 200,000 Minus fixed expenses
12,600,000 21,600,000 25,200,000 14,400,000 10,800,000 Minus variable expenses
8,200,000 14,200,000 16,600,000 9,400,000 4,600,000 Equals gross profit
1,600,000 1,600,000 1,600,000 1,600,000 1,600,000 Minus depreciation
6,600,000 12,600,000 15,000,000 7,800,000 3,000,000 Equals net operating income
2,244,000 4,284,000 5,100,000 2,652,000 1,020,000 Minus taxes (34%)
4,356,000 8,316,000 9,900,000 5,148,000 1,980,000 Equals net operating profit after taxes
$1,600,000 $1,600,000 $1,600,000 $1,600,000 $1,600,000 Plus depreciation
5,956,000 9,916,000 11,500,000 6,748,000 3,580,000 Equals operating cash flow
Taking away taxes from