Suppose that you have generated the estimates listed below from a pro forma analysis for a manufacturing company that had requested a three- year term loan. The loan is a $ 1.5 million term loan with equal annual principal payments. Principal and interest are payable at the end of each year with interest calculated against outstanding principal at a rate of prime plus 2 percent.
Year 1 Year 2 Year 3
Capital expenditures $ 250,000 $ 125,000 $ 75,000
Cash dividends $ 140,000 $ 140,000 $ 140,000
Cash flow from operations $ 750,000 $ 780,000 $ 800,000
before interest expense
a. The prime rate averages 8 percent each year. Will the firm's CFO before interest be sufficient to meet debt service requirements and other mandatory expenditures?
b. If prime averages 8 percent, 9 percent, and 10 percent over the three years, respectively, will cash flow be sufficient?