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 $260 per unit and sales volume to be 11,600 units in year 1; 26,600 units in year 2; and 6,600 units in year 3. The project has a 3 year life. Variable costs amount to $185 per unit and fixed costs are $216,000 per year. The project requires an initial investment of $372,000 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 $56,000. NWC requirements at the beginning of each year will be approximately 16% of the projected sales during the coming year. The tax rate is 34% and the required return on the project is 11%. What will the year 2 cash flows for this project be?

$1,092,300

$1,216,300

$592,300

$1,655,000

My answer so far:

I got sale will go from 3,016,000 to 6,916,000 between years 1 and 2, but I don't know how to calculate how NWC will increase. Can yo give me the detail on how to compute so that I can use it for future problems, please?

Explanation / Answer

Calculation for year 2
Sales = 6916000
Cost = Fixed cost+ Variable cost = 216000+26600*185 = 5137000
Depreciation = 372000/3 = 124000
Profit before tax = Sales- cost- depreciation = 1655000
After Tax = Profit before tax (1-T) =1092300
Cash flow without taking w into consideration = After tax Profit+depreciation = 1216300

Calculation of WC in year 2:
Working capital requirement in year 1 = 0.16*Sales = 482560
Working capital requirement in year 2 = 1106560
Net increase in working capital = 1106560-482560 = 624000
This is cash outflow

Hence total cash inflow for year 2 = 1216300-624000 = 592300

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