Financial Exercises 4: Cash flows

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by Clemens Werkmeister

1. Working capital and cash flows

Construction Partners Inc. considers submitting a proposal for a large construction project. Your task is to assess the effects on working capital and cash flows. You already prepared the expected development of the four most important positions of (net) working capital:

Year 0 1 2 3 4
Accounts receivable 10.000 50.000 125.000 90.000 10.000
Inventory 25.000 80.000 90.000 45.000 25.000
Cash 10.000 20.000 20.000 20.000 10.000
Accounts payable 15.000 60.000 60.000 50.000 15.000
Net working capital
Change in working capital

a. Calculate the net working capital for years 0 to 4.
b. What effects on the cash flow of years 0 to 4 do you expect?

2. Indirect determination of cash flows

United Eye-T presents the following income statement of a business unit:

Revenues 500.000
Cost of sales (CoGS) 200.000
Depreciation 80.000
Amortization 30.000
Selling, general and
administrative expenses (S, G & A)
Interest expense 40.000
Income Tax 30.000
Profit 50.000

a. Determine the cash flow for a discounted cash-flow (DCF)-analysis.
b. Explain and evaluate your approach.

3. Identification of relevant cash flows for NPV analysis

Project analysts of Drewmore Inc. compiled the following informations about their next project which is supposed to start next year:

  • Manufacturing will be in a plant that otherwise would be sold for 8 mio € at the end of this year.
  • Site clearance, additional buildings and installations will cost 20 mio € next year and will be depreciated over 20 years, beginning next year, too.
  • Development and management of the project is outsourced to a constructor. He charges 500.000 € for the services already delivered this year and the same amount for next year’s management.
  • Tax effects will be computed using straight line depreciation and a corporate tax rate of 35 %.
  • The project will use specific knowledge of a R&D-subsidiary which was acquired two years ago for 5 mio € and causes annual costs of 2 mio €.
  • Costs for licenses will be 200.000 € per year.
  • The project is expected to attract sales of 25 mio € per year, beginning next year.
  • Costs for human resources and raw materials are 10 mio € per year.
  • Working capital requirements will be 1 mio € next year and 1,5 mio € in year 2.
  • Overhead of Drewmore Inc. is 20 % of sales.

a. Prepare the relevant cash flows for year 0, 1 and 2.
b. Estimate the payback period based on the given information.
c. What happens if the sales forecasts include 8 mio € from existing customers and other products of Drewmore Inc.?

4. Cash flows based on accounting and tax depreciation

Solar Innos is considering a proposal to manufacture a new line of solar panels. Given its innovative design, Solar Innos expects strong sales in the next three years. After year 3, the equipment and technology will be sold to prevent losses from the expected strong international competition.
Solar Innos forecasts necessary capital investments of 10 mio € (in year 0), a resale value of equipment and technology of 1 mio € (in year 3), a tax rate of 35 % and a cost of capital of 10 %. Working capital is assumed to be 20 % of the sales. The following table resumes the sales and cost forecasts for years 0 to 4.

Year 0 1 2 3 4
Sales 0 10.000 25.000 20.000 0
Costs of goods sold 0 5.000 10.000 10.000 0
Other costs 3.000 1.000 1.000 1.000 0

a. Prepare the asset statements and the income statements for years 0 to 4, based on these informations. Assume straight line depreciation over the 3-years depreciable life of the capital investment.
b. Prepare the corresponding cash flow analysis and calculate the NPV of the solar panel project.
c. Solar innos wants to take advantage of the Modified Accelerated Cost Recovery System (MACRS). The tax depreciation factors are 33,33 % for year 1, 44,45 % for year 2, 14,81 % for year 3 and 7,41 % for year 4. Calculate the corresponding tax depreciations and the profits after taxes.
d. Prepare the cash flow analysis based on the accelerated depreciation. Calculate the NPV of the project and the advantage of the tax depreciation.

For some useful formulae you might have a look at our Financial Resources Formulary.
For further exercises we suggest our Financial Exercises.