Question

ABC Co. requires a 15% rate of return on its capital, and the firm is in the 35% marginal tax bracket. The company is considering a new project that involves the introduction of a new product. This project has a 5 year life; afterwards the product will cease to exist. Given the following information: Cost of new plant and equipment: 7,250,000 Unit sales: 80,000 (year 1), 110,000 (year 2), 110,000 (year 3), 80,000 (year 4), 60,000 (year 5) Price per unit: $230 Variable costs per unit: $140 Fixed costs: $500,000 per year Depreciation method: Straight line method over 5 years. Assume that the plant and equipment will have a salvage (market) value of $750,000 at the end of year 5. Working capital requirements: there will be an initial working capital requirement of $500,000 at the start of the project. At the end of the second year of the project, the firm will need an additional $250,000 working capital injection. Finally, all working capital is liquidated at the termination of the project at the end of year 5. Calculate the operating cash flow in year 3.

Answer 1

	0	1	2	3	4	5
Unit sales		80000	110000	110000	80000	60000
Contribution margin at $90 per unit		7200000	9900000	9900000	7200000	5400000
Fixed costs (other than depreciation)		500000	500000	500000	500000	500000
Depreciation = (7250000-750000)/5 =		1300000	1300000	1300000	1300000	1300000
Net operating income		5400000	8100000	8100000	5400000	3600000
Tax at 35%		1890000	2835000	2835000	1890000	1260000
NOPAT		3510000	5265000	5265000	3510000	2340000
Add: depreciation		1300000	1300000	1300000	1300000	1300000
Operating cash flow		4810000	6565000	6565000	4810000	3640000
				Answer