You are evaluating a product for your company. You estimate the sales price of p

Question

You are evaluating a product for your company. You estimate the sales price of product to be $50 per unit and sales volume to be 50,000 units in year 1; 75,000 units in year 2; and 10,000 units in year 3. The project has a 3-year life. Variable costs amount to $15 per unit and fixed costs are $100,000 per year. The project requires an initial investment of $275,000 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 $25,000. NWC requirements at the beginning of each year will be approximately 10% of the projected sales during the coming year. The tax rate is 34% and the required return on the project is 9%. What will the year 2 free cash flow for this project be?

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Operating Cash Flow = (Sales - Costs - Depreciation)*(1-Tax Rate) + Depreciation - Working Capital Requirement = (75000*50 -75000*15 - 100000 -275000/3)*(1-34%) + 275000/3 = $1697667

Free Cash Flow = Operating Cash Flow - Change in Working Capital = 1697667 - (-325000) = $2022667

Option D ($2022667) is the correct answer.

Notes:

Change in Working Capital = (10000 -75000)*50*10% = -325000

Thanks.

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