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Temporary Housing Services Incorporated (THSI)is considering a project that involves setting up a temporary housing facility in an area recently damaged by a hurricane.THSI will lease space in this facility to various agencies and groups providing relief services to the area.THSI estimates that this project will initially cost $5 million to set up and will generate $20 million in revenues during its first and only year in operation (paid in one year).Operating expenses are expected to total $12 million during this year and depreciation expense will be another $3 million.THSI will require no working capital for this investment.THSI's marginal tax rate is 21%.
-Ignoring the original investment of $5 million,what is THSI's free cash flow for the first and only year of operation?
A)$5.0 million
B)$3.75 million
C)$8.0 million
D)$6.95 million

Question

Quizplus · Accepted Answer

Free cash flow can be calculated by subtracting operating expenses, taxes and capital expenditures from the revenues generated.
Free cash flow = Revenues - Operating expenses - Taxes - Capital expenditures
Revenues = $20 million
Operating expenses = $12 million
Depreciation expense = $3 million
Capital expenditures = $0 million (since there is no working capital required)
Taxes = 21% of (Revenues - Operating expenses - Depreciation expense) = 0.21 x ($20 million - $12 million - $3 million) = $1.26 million
Free cash flow = $20 million - $12 million - $1.26 million - $0 million = $6.74 million
Therefore, the best choice is D, which is the closest to the calculated value of $6.74 million.

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