Chip’s Home Brew Whiskey management forecasts that if the firm sells each bottle of Snake-Bite for $20, then the demand for the product will be 15,000 bottles per year, whereas sales will be 91 percent as high if the price is raised 11 percent. Chip’s variable cost per bottle is $10, and the total fixed cash cost for the year is $100,000. Depreciation and amortization charges are $20,000, and the firm has a 30 percent marginal tax rate. Management anticipates an increased working capital need of $3,000 for the year. What will be the effect of the price increase on the firm’s FCF for the year? (Round answers to nearest whole dollar, e.g. 5,275.)
At $20 per bottle the Chip’s FCF is $ and at the new price Chip’s FCF is $.
To calculate the effect of the price increase on the firm's Free Cash Flow (FCF), we need to determine the FCF at the initial price of $20 per bottle and then at the new price.
First, let's calculate the initial FCF:
1. Calculate the total revenue at the initial price:
Total Revenue = Price per bottle * Demand per year
Total Revenue = $20 * 15,000 = $300,000
2. Calculate the total variable costs:
Total Variable Costs = Variable Cost per bottle * Demand per year
Total Variable Costs = $10 * 15,000 = $150,000
3. Calculate the earnings before interest and taxes (EBIT):
EBIT = Total Revenue - Total Variable Costs - Total Fixed Costs
Total Fixed Costs = Total Fixed Cash Costs + Depreciation and amortization charges
Total Fixed Costs = $100,000 + $20,000 = $120,000
EBIT = $300,000 - $150,000 - $120,000 = $30,000
4. Calculate the earnings before taxes (EBT):
EBT = EBIT * (1 - Tax Rate)
Tax Rate = 30% = 0.3
EBT = $30,000 * (1 - 0.3) = $21,000
5. Calculate the net income (NI):
NI = EBT - EBT * Tax rate
NI = $21,000 - $21,000 * 0.3 = $14,700
6. Calculate the Free Cash Flow (FCF):
FCF = NI + Depreciation/Amortization - Increase in Working Capital
Increase in Working Capital = $3,000
FCF = $14,700 + $20,000 - $3,000 = $31,700
Now, let's calculate the FCF at the new price with a price increase of 11%:
1. Calculate the new demand after the price increase:
New Demand = 91% * Old Demand
New Demand = 0.91 * 15,000 = 13,650
2. Calculate the new total revenue at the new price:
New Total Revenue = New Price per bottle * New Demand per year
New Price per bottle = $20 + ($20 * 0.11) = $20 + $2.20 = $22.20
New Total Revenue = $22.20 * 13,650 = $302,130
3. Calculate the new FCF using the same steps as before with the new total revenue:
New EBIT = New Total Revenue - Total Variable Costs - Total Fixed Costs = $302,130 - $150,000 - $120,000 = $32,130
New EBT = New EBIT * (1 - Tax Rate) = $32,130 * (1 - 0.3) = $22,491
New NI = New EBT - New EBT * Tax rate = $22,491 - $22,491 * 0.3 = $15,743
New FCF = New NI + Depreciation/Amortization - Increase in Working Capital = $15,743 + $20,000 - $3,000 = $32,743
Therefore, the FCF at the initial price of $20 per bottle is $31,700, and at the new price (with an 11% increase) is $32,743.