Question

You are evaluating a product for your company. You estimate the sales price of product to be $120 per unit and sales volume to be 10,200 units in year 1; 25,200 units in year 2; and 5,200 units in year 3. The project has a 3 year life. Variable costs amount to $45 per unit and fixed costs are $202,000 per year. The project requires an initial investment of $330,000 in assets which will be depreciated straight-line to zero over the 3 year project life. The actual market value of these assets at the end of year 3 is expected to be $42,000. NWC requirements at the beginning of each year will be approximately 17% of the projected sales during the coming year. The tax rate is 30% and the required return on the project is 10%. What will the year 2 cash flows for this project be?

Multiple Choice

• $1,578,000

• $1,104,600

• $1,622,600

• $1,214,600

Answer 1

Calculation of Year 2 cash flows:

Sales 25,200*120 = $3,024,000

Less: Variable Cost 25,200*45 = $1,134,000

Less: Fixed Costs = $202,000

Less: Depreciation Expense = 110,000

Income = $1,578,000

Less: Tax @ 30% = 473,400

Income after tax = $1,104,600

Add: Depreciation 110,000

cash flows = 1,214,600

Release of Net working capital = 408,000

Cash flow in Year 2 = $1,622,600

Note: Calculation of investment in NWC

Year 2 = 25,200*120*17% = $514,080

Year 3 = 5,200*120*17% = $106,080

Net release of NWC = $408,000