12-2 a. Project cash flows: t = 1 Sales revenues $15,000,000 Operating costs 13,500,000 Depreciation: 100% Bonus

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12-2 a. Project cash flows: t = 1

Sales revenues $15,000,000

Operating costs 13,500,000

Depreciation: 100% Bonus taken at t = 0 0

EBIT $ 1,500,000

Taxes (25%) 375,000

EBIT(1 – T) $ 1,125,000

Add back depreciation 0

Project cash flow = EBIT(1 – T) + DEP $ 1,125,000

b. The cannibalization of existing sales needs to be considered in this analysis on an after-tax basis, because the cannibalized sales represent sales revenue the firm would realize without the new project but would lose if the new project is accepted. Thus, the after-tax effect would reduce the project’s cash flow by $500,000(1 – T) = $500,000(0.75) = $375,000. Thus, the project’s cash flow would now be $750,000 rather than $1,125,000.

1. Why is interest expense excluded from the calculation of Cash Flow?

2. Why is depreciation added back to arrive at Cash Flow?

3. If sales were cannibalized by $1.5 Million, why is the effect on Cash flow a reduction of only $900,000