Caledonia

Caledonia Products Mini-Case

Lisa Dempsey, Michelle Livengood, Angie Mammon, Clystal Mehnert,

Gina Mortimore, Jason Simon, Carmin Weber

FIN/370

March 11, 2013

Dr. Tami Bolder

1.

Caledonia should focus on free cash flow rather than accounting profits because the free cash flow is what the organization receives, which can then be reinvested. Through thoroughly analyzing the free cash flow, Caledonia would be able to determine the actual benefit or the cost involved. The organization should primarily focus on the incremental cash flow because the incremental cash flow holds a marginal benefit from the project. Depreciation is considered to be an expense item which means that the greater the depreciation, the larger the expense will be to the organization. Therefore, if Caledonia was looking at the project from an accounting profit view, the profit would be much lower than that of the free cash flow.

Without profit the business cannot survive. But profit does not always result in cash flow, and without cash flow, the business has trouble operating. What is important is for the profit to become cash flow as quickly as possible. Cash flow from borrowing or selling fixed assets can only help in the short run, but if it is not offset by cash flow from operating profit, the business is dead.

2.

Following are the incremental cash flows for years 1-5 for Caledonia Products project analysis:

Year 1 $8,200,000

Year 2 $14,200,000

Year 3 $16,600,000

Year 4 $9,400,000

Year 5 $4,600,000

Accounting profits or earnings are $1,600,000 less each year due to the depreciation aspect of the project. Accounting profits do matter in the overall picture of the financial health of the company. This will let management know if it will at a bottom line level be good for the company. A very important point for management to know is whether they will be sacrificing cash flow (which can be crucial for some businesses at specific times). For example, if a project will be overall...