Bus401 - Final Project Caledonia Products

Caledonia Products Cash Flow Analysis

Nicole Albanez-Ferreira

November 26, 2012

BUS401 Principles of Finance

Mr. George Murphy

Caledonia Products Cash Flow Analysis

As a newly appointed employee with Caledonia Products, it is my pleasure to prove I deserve my title as assistant financial analyst by conducting a thorough analysis of a potential investment. Caledonia Products is considering introducing a new product that will only be produced for five years; Caledonia Products is in the 34 percent marginal tax bracket and requires a 15 percent rate of return on the investment. The capital-budgeting process can be daunting to most people, but a step-by-step analysis of the project cash flow for the proposed new product, along with additional information on select terms, will allow complete understanding of what is to be gained by undertaking this project. The following will discuss why cash flows are more useful than accounting profits in this situation, the effect of depreciation and sunk costs on cash flows, the project’s cash flow calculations, my professional recommendation, and an analysis on the risks associated with the project.

Cash Flows versus Accounting Profits

Accounting profits and cash flows both represent a company’s overall financial health, but the means of gaining the complete financial picture differ greatly. “A major disadvantage of using the accounting profit method of calculation is that it's more time consuming and complex. For calculating cash flows, there's only one method of calculation to use, but several different methods exist for calculating accounting profits” (Robertson, 2012, para. 5). In addition to the single method, cash flows also allow the company to receive and reinvest free cash flows because “free cash flows correctly reflect the timing of benefits and costs-that is, when the money is received, when it can be reinvested, and when it must be paid out” (Keown, Martin, & Petty, 2011, p. 303). For these reasons, Caledonia...