Caledonia ProductsCalculating Free Cash Flow and Project Valuation Itâs been two months since you took a position as an assistant financial analyst at Caledonia Products. Although your boss has been pleased with your work, he is still a bit hesitant about unleashing you without supervision.Your next assignment involves both the calculation of the cash flows associated with a new investment under consideration and the evaluation of several mutually exclusive projects. Given your lack of tenure at Caledonia, you have been asked not only to provide a recommendation, but also to respond to a number of questions aimed at judging your understanding of the capital-budgeting process. The memorandum you received outlining your assignment follows:To: The Assistant Financial AnalystFrom: Mr. V. Morrison, CEO, Caledonia ProductsRe: Cash Flow Analysis and Capital RationingWe are considering the introduction of a new product. Currently we are in the 34% tax bracket with a 15% discount rate. This project is expected to last five years and then, because this is somewhat of a fad project, it will be terminated. The following information describes the new project:Cost of new plant and equipment: $ 7,900,000Shipping and installation costs: $ 100,000Unit sales:Sales price per unit: $300/unit in years 1â4 and$260/unit in year 5.Variable cost per unit: $180/unitAnnual fixed costs: $200,000 per yearWorking capital requirements: There will be an initial working capital requirement of $100,000 just to get production started. For each year, the total investment in net working capital will be equal to 10% of the dollar value of sales for that year. Thus, the investment in working capital will increase during years 1 through 3, then decrease in year 4. Finally, all working capital is liquidated at the termination of the project at the end of year 5.Depreciation method: Straight-line over 5 years assuming the plant and equipment have no salvage value after 5 years.Year Units Sold1 70,0002 120,0003 140,0004 80,0005 60,000
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