Anderson Group Inc. is starting a new project which will last for four years. In year 1, the firm is expecting sales of $400,000 and costs of goods sold (COGS) are expected to be 80% of sales. The project will require $20,000 in fixed costs per year and an initial capital expenditure with depreciation expenses of $5,000 per year. No incremental changes in net working capital will be required. Anderson Group Inc. faces a marginal tax rate of 40%. What is the Incremental Free Cash Flow (FCF) of the project in year 1?

(Hint: Round your answer to the nearest integer, i.e., no decimal points.)

Question

Anderson Group Inc. is starting a new project which will last for four years. In year 1, the firm is expecting sales of $400,000 and costs of goods sold (COGS) are expected to be 80% of sales. The project will require $20,000 in fixed costs per year and an initial capital expenditure with depreciation expenses of $5,000 per year. No incremental changes in net working capital will be required. Anderson Group Inc. faces a marginal tax rate of 40%. What is the Incremental Free Cash Flow (FCF) of the project in year 1?

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(Hint: Round your answer to the nearest integer, i.e., no decimal points.)

BlackTom AI · Accepted Answer

Free cash flow (FCF) = after-tax operating income (NOPAT) + noncash expenses (depreciation) − capital expenditures − change in net working capital. Depreciation is a noncash expense and must be added back; initial capex occurs at time 0 so no additional capex is subtracted in year 1; ΔNWC = 0 as stated.

Step-by-step calculation with intermediate values:
1. Sales = $400,000.
2. COGS = 80% of sales = 0.80 × $400,000 = $320,000.
3. Fixed costs = $20,000.
4. Depreciation = $5,000 (noncash).
5. EBIT = Sales − COGS − Fixed costs − Depreciation
   = $400,000 − $320,000 − $20,000 − $5,000
   = $55,000.
6. Taxes = Tax rate × EBIT = 0.40 × $55,000 = $22,000.
7. NOPAT = EBIT − Taxes = $55,000 − $22,000 = $33,000.
8. FCF = NOPAT + Depreciation − CapEx − ΔNWC
   = $33,000 + $5,000 − $0 − $0
   = $38,000.

Why this is correct: EBIT is taxed, producing NOPAT, and depreciation (a noncash deduction used to compute EBIT) must be added back to get cash generated by operations. No incremental working capital or additional capex in year 1 reduces nothing further.

Common mistakes (why other answers would be wrong):
- Forgetting to add back depreciation yields $33,000 (understates FCF).
- Taxing revenue instead of EBIT or using wrong tax base gives incorrect tax and NOPAT.
- Subtracting initial capex in year 1 would be wrong if that capex is at time 0 (unless the problem explicitly said additional capex in year 1).

Conclusion: The incremental FCF in year 1 is $38,000, which matches the provided answer (38000).

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