Caledonia

Caledonia Products Integrative Problem

Caledonia Products is considering a new product and need to determine why Caledonia should focus on project free cash flows as opposed to the accounting profits earned by the project when analyzing whether to undertake the project. Caledonia Products will also need to determine the incremental cash flows for the project in years 1 through 5 and show how the cash flows differ from accounting profits or earning. This will assist in determining if the product will be accepted or not, Mr. V. Morrison, CEO, Caledonia Products (Mr. Morrison) gave a relatively new assistant financial analyst the project to judge his understanding of capital-budgeting process.

The analyst is focusing on project free cash flows as opposed to the accounting profits the project will earn because accounting breakeven point tells the analyst the level of sales necessary. To cover the total fixed and variable operating costs where total fixed costs include both cashed fixed costs and depreciation expense (which is not a cash expense for the period) (Sheridan Titman, 2011). Free cash flows are used to because they only consider the fixed costs that specifically require a cash payment by the firm. Mr. Morrison wants an analysis for years 1 through 5 and the project free cash flows is the most efficient to evaluate the viability of the new product, the synergistic affects, and possible incremental cash flows relevant to the valuation of an investment project.

Below the spreadsheet shows the incremental cash flows for the project in years 1 through 5. See the numbers in the (CFAT) column of the spreadsheet; also, the way these differ from accounting profits or earnings is cash flow statements measure the business’s net cash flow, or the change in its cash and cash equivalents. Accounting profits include non-cash based revenues and expenses, while net cash flow includes transactions other than revenues and expenses.

Caledonia...