Question 1. Operating cash flow - Eisenhower Communications is trying to estimate the first-year operating cash flow (at T=1) for a proposed project. The financial staff has collected the following information:
Projected sales $10 million
Operating costs (excluding depreciation) 7 million
Depreciation 2 million
Interest expense 2 million
The company faces a 40 percent tax rate. What is the projects operating cash flow for the first year (t=1)?
Question 2. Breakeven quantity - A company estimates that its fixed operating costs are $500,000, and its variable costs are $3.00 per unit sold. Each unit produced sells for $4.00. What is the company's breakeven point? In other words, how many units must sell before its operating income becomes positive?
Question 3. A firm has $100 million available for capital expenditures. It is considering investing in one of two projects: each has a cost of $100 million. Project A has an IRR of 20 percent and an NPV of $9 million. It will be terminated at the end of 1 year at a profit of $20 million, resulting in an immediate increase in earnings per share (EPS). Project B, which cannot be postponed, has an IRR of 30 percent and an NPV of $50 million. However, the firm's short run EPS will be reduced if it accepts Project B, because no revenues will be generated for several years.
a. Should the short-run effects on EPS influence the choice between the two projects?
b. How might situations like the one described here influence a firm's decision to use payback as a part of the capital budgeting process?