Question

Your firm is considering producing a new variety of widget. You have already test marketed

the widgets at a cost of $90,000. You estimate sales will be $500,000 in the first year, $800,000

in the second year, $500,000 in the third year, and zero after three years.

To produce the new widgets will require an investment in working capital at year 0 of $50,000.

Net working capital will be 20% of sales in years 1 and 2. Labor, materials, and selling

expenses will be 60% of sales. An additional $80,000 in promotional expenses will be incurred

in the first year of production.

You already own sufficient widget-producing equipment to produce the new variety of widget.

The equipment was purchased for $1 million, has a book value of $600,000, and is being

depreciated at the rate of $200,000 per year. You don't anticipate any use for the surplus

capacity of this equipment other than this new variety of widget.

To produce the new widgets, you will, however, need additional packaging equipment. The

equipment costs $100,000. It will be depreciated straight-line to zero over two years, beginning

in the first year of production. The equipment will have no value after three years.

Production will also require the use of warehouse space. If this space is not used for the new

widgets, it can be rented for $40,000 per year.

The tax rate is 40% and the cost of capital is 12%.

What is the year 0,1,2, and 3 increase in Net working capital?

Answer 1