James Kochiel, Erik Nutt, Lynnell Smothers, Derek Wright
January 21, 2014
1. Why should Caledonia focus on project free cash flows as opposed to the accounting profits earned by the project when analyzing whether to undertake the project?
Caledonia should focus on cash flows, because free cash flows can be reinvested when received, unlike accounting profits which are shown when earned, and not at the time cash is received. The company should focus on incremental after-tax cash flows. This enables it to analyze the profits or losses after comparing cash flows with or without the project on an after tax basis. …show more content…
6. What is its internal rate of return? Using the excel function, the Internal Rate of Return for Project A is 18.03% and the IRR for Project B is 14.87%.
7. Should the project be accepted? Why? or Why not ?
Project B should be accepted because it has a higher NPV. Generally, NPV is the preferred method when trying to choose a project because it reflects the growth of the financial wealth of a company.
Factors that Caledonia must consider if it were to consider leasing versus buying are depreciation, salvage value, and investment outlay. If Caledonia were to lease the property and equipment for production of product, then the cost associated with the lease would be a cash flow item and would affect the calculations for Net Present Value (NPV) and Internal Rate of Return (IRR). If Caledonia made the decision to purchase the property and equipment for the production of product, then the depreciation on the real property would not be a cash flow item. Similarly, the depreciation of purchased equipment would also not be a cash flow item. However, the depreciation on plant and equipment can be used to reduce Caledonia’s tax liability each year and this would in-turn increase cash flows each year. Caledonia must also consider, since this is a project with a finite time limit, the salvage value of the plant and equipment at the end of the five years of its