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Diversified Industries manufactures sump-pumps. Its most popular product is called the Super Soaker, which has a retail price of \(1,200 and costs \)540 to manufacture. It sells the Super Soaker on a standalone basis directly to businesses. Diversified also provides installation services for these commercial customers, who want an emergency pumping capability (with regular and back-up generator power) at their businesses. Diversified also distributes the Super Soaker through a consignment agreement with Menards. Income data for the first quarter of 2017 from operations other than the Super Soaker are as follows.

Revenues: \(9,500,000

Expenses: \)7,750,000

Diversified has the following information related to two Super Soaker revenue arrangements during the first quarter of 2017.

1. Diversified sells 30 Super Soakers to businesses in flood-prone areas for a total contract price of \(54,600. In addition to the pumps, Diversified also provides installation (at a cost of \)150 per pump). On a standalone basis, the fair value of this service is \(200 per unit installed. The contract payment also includes a \)10 per month service plan for the pumps for 3 years after installation (Diversified’s cost to provide this service is \(7 per month). The Super Soakers are delivered and installed on March 1, 2017, and full payment is made to Diversified. Any discount is applied to the pump/installation bundle.

2. Diversified ships 300 Super Soakers to Menards on consignment. By March 31, 2017, Menards has sold two-thirds of the consigned merchandise at the listed price of \)1,200 per unit. Menards notifies Diversified of the sales, retains a 5% commission, and remits the cash due Diversified.

Analysis

Determine free cash flow (see Chapter 5) for Diversified Industries for the first quarter of 2017. In the first quarter, Diversified had depreciation expense of \(175,000 and a net increase in working capital (change in accounts receivable and accounts payable) of \)250,000. In the first quarter, capital expenditures were \(500,000; Diversified paid dividends of \)120,000.

Step by step solution

01

Definition of Free Cash Flow

The cash that remains in the hand of the company after adjusting the capital expenditure made is known as free cash flow. Investors also use it to determine the performance of the business.

02

Calculation of free cash flow

Particular	Amount $
Net income	$1,894,000
Add: Depreciation expenses	$175,000
Less: Increase in working capital	($250,000)
Less: Capital expenditure	($500,000)
Less: Dividend	($120,000)
Free Cash Flow	$1,199,000

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