If the Coat Fits Wear It


3)Working Capital
: Working Capital is considering what the best way would be in terms of a management for short-term resources and obligations. The concept of this decision focuses on if it is possible to maintain enough capital for payments of its bills including and extra money earned as interest. Current assets and current liabilities are considered as the part of this decision.

In order to arrive at the non-operating cash flows in year 10, we must add together the net cash flows from investing and financing activities.  The non-operating cash flow when the project is terminated in year 10 is $902,000.

Here is a rundown of the variables we used to first determine the cash flows for Years 0 through 10: depreciation of equipment over the 10 years, sales minus COGS to identify gross profit, summed expenses (advertising, start-up, and Jell-o erosion only; the test market expense in Year 1 is considered a sunk cost and thus should not be included), and subtracted taxes to come up with the cash flow. When assessing the below issues, the team concluded the following

Before moving forward to compute the present value of these cash flows, a terminal value is required to forecast the long term value of the company after 5 years. . Following formula is used to calculate the terminal value.

1. The first step to evaluating the cash flows is to conduct the depreciation tax flow analysis. Depreciation is not a cash flow, but the depreciation expense lows the taxes payable for the company. As a result, the tax effect of deprecation needs to be calculated as a cash flow. There are two depreciable items on the company's balance sheet the building and the equipment. The equipment is known to have a seven year depreciable life, which will be assumed to be straight line. The building is also assumed to be subject to straight line depreciation, this time of forty years. The tax saving reflects the depreciation expense multiplied by the tax rate, which in this case is assumed to be 28%. The following table illustrates the tax effect in future dollars of the depreciation expense:

Working capital is the key to a successful business. It is like their blood flow and the manager’s job is to help keep it flowing. Under the Generally Accepted Accounting Principles working capital is simply the difference between a company’s Current Assets, which are cash, inventory, accounts receivable and prepaid items, and Current Liabilities, accounts payable and accrued expenses.

Next, the terminal value at year ten was calculated. The following formula was used to do so: terminal value at year 10 = (FCF at year 11)/(WACC - g). This time we used the long-term growth rate of 7up, which was given by the case as 1% less than the industry rate. This resulted in a terminal value of $848M with its present value calculation being $231M.

Depreciation:      Depreciation was not included in the calculation of free cash flows because net CAPX was used.

1. Two commonly used methods of financial analysis are payback and present value. Payback determines the length of time for an investment to return its original cost (1). Using the assumptions stated below the payback of the Jiminy Nick wind turbine with a cost of about $3.3 million would return the investment in about four years time. Net present value summarizes the initial cost of an investment, the estimated annual cash flows, and expected salvage value, taking into account the time value of money (1). A NPV calculation for the scenario SED is reviewing equals $7,697,286 minus the investment costs of $3,318,000 totaling $4,379,286.

1. Jensen Company purchased a new machine on September 1, 2012, at a cost of $128,000. The company

The free cash flow method is used to gauge “a company’s cash flow beyond that necessary to grow at the current rate… [to ensure companies] make capital expenditures to continue to exist and to grow” (Drake, n.d.). Calculation of free cash flows utilizes various components, including a firm’s value, cash flow forecasts, a firm’s capital structure, the cost of capital, and/or discounted cash flows.

The company use $12,000 to purchase Equipment and $8,000 to purchase Inventory. The outflow of resource is therefore ($12,000 + $8,000) $20,000 and the present cash level at ($25,000 - $20,000) $5,000.

The actual production would begin in the third quarter of this year, therefore only half year’s depreciation should be counted on Equipment and IT communication in 2004 (According to Appendix A). The following years (2005-2008) incremental cash flows are computed by the same method. However as the IT equipment and furnishings would be depreciated on a straight line basis over 3 years, thus in year four (2007), there would be only half a year’s deprecation left and after that it will be used up. The last year’s net cash flow in 2009 should be included the extra terminal Value on that year, which includes 24 years’ residual value on building and one year and a half residual value on equipment totaled $2,990,412 with two assumptions of by using residual book values for the building and operating equipment and there will be no further NWS advantage after year 2009. Finally, by obtaining 6 years’ incremental cash-flows and discounting them back to time zero (with the estimate rate of return by 15%) lessing initial cost to get an appealing NPV of $1190528 (Luehrman, p. 3).

3. Regarding the cash flow forecasts in case Exhibit 5, at what point in the future would you set the forecast horizon for the three investments? Why? More generally, what should determine when you stop forecasting annual cash flows and estimate a terminal value?

I would estimate the incremental cash flows over the economic life of the new machine, taking into consideration the after-tax salvage values of the old and new machine respectively. Changes in net working capital would be figured in as well. For the terminal year, we would assume that the net working capital is recovered and treat it as a cash inflow.