Introduction to Corporate Finance

10: Cash Flow and Capital Budgeting

inventory beyond those already reflected in the financial projection. TGI also enjoys a higher

credit rating than Fusion, so after the acquisition, Fusion will obtain credit from suppliers on

more favourable terms. Specifically, Fusion’s accounts payable balance will be 30% higher

each year than the level currently forecast.

4 TGI’s current cash reserves are more than sufficient for the combined firm, so Fusion’s existing
cash balances will be reduced to $0.

5 Immediately after the acquisition, TGI will invest $50 million in fixed assets to manufacture a
new chip that integrates Fusion’s technology into one of TGI’s best-selling products. These
assets will be depreciated on a straight-line basis for eight years. After five years, the new chip
will be obsolete, and no additional sales will occur. The equipment will be sold at the end of
year 5 for $1 million. Before depreciation and taxes, this new product will generate $20 million
in (incremental) profits the first year, $30 million the second year, and $15 million in each of the
next three years. TGI will have to invest $3 million in net working capital up front, all of which it
will recover at the end of the project’s life.

6 Both firms face a tax rate of 34%.

Fusion Chips income statements

($ in thousands, for year ended 31 December)

2014 2015 2016 2017 2018

Sales $100,000 $150,000 $200,000 $240,000 $270,000

Cost of goods sold 60,000 90,000 120,000 144,000 162,000

Gross profit $ 40,000 $ 60,000 $ 80,000 $ 96,000 $108,000

Operating

expenses

12,000 17,250 22,000 25,200 27,000

Depreciation 12,000 18,000 24,000 28,800 32,400

Pre-tax income $ 16,000 $ 24,750 $ 34,000 $ 42,000 $ 48,600

Taxes 5,440 8,415 11,560 14,280 16,524

Net income $ 10,560 $ 16,335 $ 22,440 $ 27,720 $ 32,076

Fusion Chips assets and accounts payable 2013– 2018

($ in thousands, on 31 December)

2013 2014 2015 2016 2017 2018

Cash $ 400 $ 400 $ 525 $ 600 $ 600 $ 600

Accounts

receivable

6,000 7,000 10,500 14,000 16,800 18,900

Inventory 10,000 12,500 18,750 25,000 30,000 33,750

Total current assets $16,400 $ 19,900 $ 29,775 $ 39,600 $ 47,400 $ 53,250

Plant and

equipment

Gross $80,000 $113,000 $166,500 $226,000 $283,200 $336,900

Net $50,000 $ 71,000 $106,500 $142,000 $170,400 $191,700

Total assets $66,400 $ 90,900 $136,275 $181,600 $217,800 $244,950

Accounts payable $ 7,500 $ 13,500 $ 20,250 $ 27,000 $ 32,400 $ 36,450

Note: The 2013 figures represent the balances currently on Fusion’s balance sheet.