Question

Sales for year 2 of a new project are expected to increase by 12.50%. For every dollar increase in sales, current assets are expected to increase by 19.70% and current liabilities by 5.65%. For year 2, calculate the change in net working capital as a percentage of year 1 sales.

Answer 1

Let sales in year 1 be $100

So, when Sales for year 2 of a new project are expected to increase by 12.5%

Sales in year 2 = 100*(1 + 0.125) = $112.50

So, dollar increase in sales = sales in year 2 - sales in year 2 = 112.50 - 100 = $12.50

For every dollar increase in sales, current assets are expected to increase by 19.70% and current liabilities by 5.65%

So, dollar increase in current asset = dollar increase in sales*(1+increase in current assets) = 12.5*(1+0.197) = $14.96

Similarly, dollar increase in current liabilities = dollar increase in sales*(1+increase in current liabilities) = 12.5*(1+0.0565) = $13.20

So, change in net working capital = Increase in current assets - increase in current liabilities = 14.96 - 13.20 = 1.76

So, change in net working capital as a percentage of year 1 sales = Change in NWC/sales in year 1 = 1.76/100 = 1.76%

Option E is correct.