Prepare a response to the following case study problem. Caledonia Services is lo
ID: 2625475 • Letter: P
Question
Prepare a response to the following case study problem. Caledonia Services is looking to invest in a new software platform. You have been tasked to decide if the cash flows from the project are adequate: The following expectations for the project have been given to you:
Cost of new servers and building $10,000,000. Depreciation is over five years on a straight-line basis and at the end of five years the servers and building will be sold for an expected $1,000,000.
Fixed costs are $300,000 per year.
Unit software sales from the new platform are expected to be as follows:
Year 1 50,000
Year 2 100,000
Year 3 150,000
Year 4 150,000
Year 5 100,000
The product will sell for $300/unit in years 1-3; $250 in years 4 and 5
Variable costs are $200/unit
At the start of the project Caledonia will need $200,000 in cash for working capital. For years 1-5 additional working capital will be needed equal to 10% of sales revenues in addition to the initial $200,000. The cash flow impact is the netincrease/decrease in working capital in each year. All working capital is released in year 5.
There is a 35% tax rate and the company
Explanation / Answer
depriciation per year = 10000000/5 = 2000000
cash flow year1 = (50000 * 300 - 50000 * 200 - 300000) * (1-0.35) + 2000000 * 0.35 - 3000000= 755000
cash flow year 2 = (100000 * 300 - 100000 * 200 - 300000) * (1-0.35) + 2000000 * 0.35 -4500000 = 2505000
cash flow year3 = (150000 * 300 - 150000 * 200 - 300000) * (1-0.35) + 2000000 * 0.35 - 3750000= 6505000
cash flow year 4 = (150000 * 250 - 150000 * 200 - 300000) * (1-0.35) + 2000000 * 0.35 -2500000= 6630000
cash flow year 5 = (100000 * 250 - 100000 * 200 - 300000) * (1-0.35) + 2000000 * 0.35 + 200000 + 1000000 * (1-0.35) + 15250000
= 21500000
intial cashh outlay = 10000000 + 200000 + 1500000 = 2700000