Question

You are evaluating a project for The Farpour golf club, guaranteed to correct that nasty slice. You estimate the sales price of The Tiff-any to be $400 per unit and sales volume to be 1000 units in year 1; 1500 units in year 2; and 1325 units in year 3. The project has a three-year life. Variable costs amount to $225 per unit and fixed costs are $100,000 per year. The project requires an initial investment of $165,000 in assets which will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $35,000. NWC requirements at the beginning of each year will be approximately 20 percent of the projected sales during the coming year. The tax rate is 34 percent and the required return on the project is 10 percent. What change in NWC occurs at the end of year 1?

Answer 1

Year 1:

Unit Sales = 1,000
Selling Price = $400 per unit

Sales = Unit Sales * Selling Price
Sales = 1,000 * $400
Sales = $400,000

NWC required at the beginning of Year 1 = 20% * Sales in Year 1
NWC required at the beginning of Year 1 = 20% * $400,000
NWC required at the beginning of Year 1 = $80,000

Year 2:

Unit Sales = 1,500
Selling Price = $400 per unit

Sales = Unit Sales * Selling Price
Sales = 1,500 * $400
Sales = $600,000

NWC required at the beginning of Year 2 = 20% * Sales in Year 2
NWC required at the beginning of Year 2 = 20% * $600,000
NWC required at the beginning of Year 2 = $120,000

Change in NWC at the end of Year 1 = NWC required at the beginning of Year 2 - NWC required at the beginning of Year 1
Change in NWC at the end of Year 1 = $120,000 - $80,000
Change in NWC at the end of Year 1 = $40,000