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Calculating Annual Project Free Cash Flow

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In the spring of 2010, Jemison Electric was considering an investment in a new distribution center. Jemisons CFO anticipates additional earnings before interest and taxes (EBIT) of \$ 100,000 for the first year of operation of the center in 2011, and, over the next five years, the firm estimates that this amount will grow at a rate of 5% per year. The distribution center will require an initial investment of \$ 400,000 that will be depreciated over a five- year period toward a zero salvage value using straight-line depreciation of \$ 80,000 per year. Furthermore, Jemison expects to invest an amount equal to the firms annual depreciation expense in the prior year to maintain the physical plant. These additional capital expenditures will also be depreciated over a period of five years toward a zero salvage value. Jemisons CFO estimates that the distribution center will need additional net working capital equal to 20% of new EBIT (i.e., the change in EBIT from year to year). Assuming the firm faces a 30% tax rate, calculate the project's annual project free cash flow (FCF) for each of the next five years.

Solution Summary

This solution calculated the free cash flow for a project involving a distribution center.

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Free Cash Flow (FCF) is calculated as follows: EBIT * (1 - Tax Rate) + Depreciation & Amortization - ...

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