Operating Cash Flows

Presentation with question on operating cash flow.

1. Operating Cash flow Wasif Ali Syed (18221554-001)

2. What is operating cash flows? Operating cash flow (OCF) is a measure of the amount of cash generated by a company's normal business operations. Operating cash flow indicates whether a company can generate sufficient positive  cash flow  to maintain and grow its operations, otherwise, it may require external financing for capital expansion .

3. Formulas for calculation of operating cash flows OCF = ( Δ EBIT)(1 – tax rate) + Δ Depreciation OCF= ( Δ EBDIT – Δ Depreciation)(1 – tax rate) + Δ Depreciation OCF= ( Δ Revenues – Δ Expenses – Δ Depreciation)(1 – tax rate) + Δ Depreciation Where as: Δ Revenues= Revenues with project (new asset) - Revenues without project (old asset) Δ Expenses= Expenses with project (new asset) - Expenses without project (old asset) Δ Depreciation= Depreciation with project (new asset) - Depreciation without project (old asset )

4. Question Year Revenues Expenses 1 1400,000 1375,000 2 1450,000 1400,000 3 1500,000 1420,000 4 1500,000 1400,000 5 1380,000 1370,000 Question: Jack Corporation has planned to replace its old machine with new one and desires to determine operating cash flows. The purchase price of new machine is $300,000 and installation cost is $20,000. New machine will be depreciated under 5 years MACRS. The old machine was acquired 3 years ago at a cost of $200,000, is being depreciated using 5 years MACRS and can be used for next 5 years. The estimates of its revenue and expenses (excluding depreciation and interest), with and without the proposed new machine are given below (tax rate=40 %): with proposed machine with new machine Year Revenues Expenses 1 1800,000 1500,000 2 1830,000 1520,000 3 1880,000 1550,000 4 1820,000 1515,000 5 1770,000 1475,000

5. solution Δ Revenues= Revenues with project (new asset) - Revenues without project (old asset) Year 1 =1,800,000 – 1,400,000= 400,000 Year 2 =1,830,000 – 1,450,000= 380,000 Year 3 =1,880,000 – 1,500,000= 380,000 Year 4 =1,820,000 – 1,500,000= 320,000 Year 5 =1,770,000 – 1,380,000= 390,000 Δ Expenses= Expenses with project (new asset) - Expenses without project (old asset) Year 1 =1,500,000 – 1,375,000= 125,000 Year 2 =1,520,000 – 1,400,000= 120,000 Year 3 =1,550,000 – 1,420,000= 130,000 Year 4 =1,515,000 – 1,400,000= 115,000 Year 5 =1,475,000 – 1,370,000= 105,000

6. solution Δ Depreciation= Depreciation with project (new asset) - Depreciation without project (old asset) Year 1 =64,000 – 23,040= 40,960 Year 2 =102,400 – 23,040= 79,360 Year 3 =61,440 – 11,520= 49,920 Year 4 =36,864 – 0= 36,864 Year 5 = 36,864 – 0= 36,864 Depreciation New asset Depreciation old asset Year 5 years Depreciation Exp.=Asset cost x dep. Rate Depreciation Exp.=Asset cost x dep. Rate 1 20% =320,000 x 0.20= 64,000 =200,000 x 0.20= 40,000 2 32 =320,000 x 0.32= 102,400 =200,000 x 0.32= 64,000 3 19.2 =320,000 x 0.192= 61,440 =200,000 x 0.192= 38,400 4 11.52 =320,000 x 0.1152= 36,864 =200,000 x 0.1152= 23,040 5 11.52 =320,000 x 0.1152= 36,864 =200,000 x 0.1152= 23,040 6 5.76 = 320,000 x 0.0576= 18,432 = 200,000 x 0.0576= 11,520

7. Solution OCF= ( Δ Revenues – Δ Expenses – Δ Depreciation)(1 – tax rate) + Δ Depreciation Year 1= (400,000 – 125,000 – 40,960)(1 – 0.4) + 40,960= 181,384 Year 2= (380,000 – 120,000 – 79,360)(1 – 0.4) + 79,360= 187,744 Year 3= (380,000 – 130,000 – 49,920)(1 – 0.4) + 49,920= 169,968 Year 4= (320,000 – 115,000 – 36,864)(1 – 0.4) + 36,864= 137,746 Year 5= (390,000 – 105,000 – 36,864)(1 – 0.4) + 36,864= 185,746