Caledonia Products Term Paper

Open, View, and/or
Download this Document

Total Length: 1290 words ( 4 double-spaced pages)

Total Sources: 5

Page 1 of 4

Caledonia Products

a) When making capital budgeting decisions, Caledonia should focus on cash flows rather than accounting profits. The argument in favor of cash flows is simple -- cash flows are what drive company value, more so than economic profit. Profit can be distorted by a number of considerations that do not impact on cash flows. For example, depreciation expense is not a cash flow, but a means of accounting for the fact that the up front purchase is not on the income statement. By using cash flows, it is easier to account for the time value of money because the cash flows are represented in the time period in which they occur -- that is not always the case with accounting for economic profit.

b) Depreciation is not included in the calculation of cash flows, because it is not a cash flow. The item that depreciation represents is the initial purchase. Depreciation, does however, have an impact on cash flows. Depreciation is an expense that lowers the EBITDA. This in turn results in a decreased tax obligation. Thus, the impact of depreciation on the cash flows is encapsulated in the "depreciation tax credit" of the net present value (NPV) calculation. This represents the after-tax cash benefit of the depreciation expense associated with the project.

c) Sunk costs are irrelevant to the cash flows. When making a capital budgeting decision, it is important to remember that any money already spent cannot be recouped no matter what decision is made. The money is gone. The decision about what to do in the future is not related to decisions that were made in the past; the decision only relates to cash flows that are directly impacted by the decision at hand.

d) The project's initial outlay is $8.1 million.

Stuck Writing Your "Caledonia Products" Term Paper?

View All Our Example Caledonia Products Term Paper

Have A Custom Example Essay Written

This consists of three components. The largest of these is the initial purchase, which is $7.9 million for the equipment. Shipping and installation accounts for a further $100,000 of the initial outlay. Lastly, $100,000 in working capital is needed to get the project off the ground. This is also included in the initial outlay because it is needed now.

e) The differential cash flows over the project's life are $47.686 million in future value. These cash flows represent the sum total of cash flows associated with the investment decision, from the initial outlay to annual flows to the terminal cash flow.

f) The terminal cash flow is the flow at the end of the project. In this case, the termination of the project comes at the end of the fifth year. Given that all revenues and costs in that year are also assumed to come at the end, the terminal cash flow used in the calculation also includes the final year revenues and costs. This gives a total final year cash flow of $7.5372 million in future value. Excluding the revenue and cost components, the terminal cash flow only includes the working capital that is liquidated upon project termination. This is $2.4 million. The equipment is not expected to have a salvage value, so liquidating the working capital is the only thing that will occur at the very end of the project.

g)

h) The net present value of this project is $29.099 million. This is calculated as follows:

Year

0

1

2

3

4

5

Initial Cost

(7,900,000)

Installation

(100,000)

Revenue

21,000,000

36,000,000

42,000,000

24,000,000

15,600,000

Variable Costs

(12,600,000)

(21,600,000)

(25,200,000)

(14,400,000)

(10,800,000)

Fixed Costs

(200,000)

(200,000)

(200,000)

(200,000)

(200,000)

Working Cap

(100,000)

(2,000,000)

(1,500,000)

(600,000)

1,800,000

2,400,000

Dep Exp Ben

537,200

537,200.....

Show More ⇣

     Open the full completed essay and source list


OR

     Order a one-of-a-kind custom essay on this topic


sample essay writing service

Cite This Resource:

Latest APA Format (6th edition)

Copy Reference
"Caledonia Products" (2011, November 19) Retrieved May 6, 2024, from
https://www.aceyourpaper.com/essays/caledonia-products-47691

Latest MLA Format (8th edition)

Copy Reference
"Caledonia Products" 19 November 2011. Web.6 May. 2024. <
https://www.aceyourpaper.com/essays/caledonia-products-47691>

Latest Chicago Format (16th edition)

Copy Reference
"Caledonia Products", 19 November 2011, Accessed.6 May. 2024,
https://www.aceyourpaper.com/essays/caledonia-products-47691
   

Open, View, and/or
Download this Document
order custom essay example