Project Cash Flows You are evaluating a project for The Ultimate recreational te
ID: 2762898 • Letter: P
Question
Project Cash Flows You are evaluating a project for The Ultimate recreational tennis racket, guaranteed to correct that wimpy backhand. You estimate the sales price of The Ultimate to be $400 per unit and sales volume to be 1,000 units in year 1; 1,250 units in year 2; and 1,325 units in year 3. The project has a 3-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 3-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 will the cash flows for this project be?
Explanation / Answer
Year
1
2
3
Units Sold
$1,000.00
$1,250.00
$1,325.00
Sales
$400,000.00
$500,000.00
$530,000.00
Less: Variable Cost
$225,000.00
$281,250.00
$298,125.00
Less: Fixed Cost
$100,000.00
$100,000.00
$100,000.00
Less: Depreciation
$55,000.00
$55,000.00
$55,000.00
EBIT
$20,000.00
$63,750.00
$76,875.00
Less: tax @ 34%
$6,800.00
$21,675.00
$26,137.50
Net Income
$13,200.00
$42,075.00
$50,737.50
Add: Change in NWC
-$80,000.00
-$100,000.00
-$106,000.00
Add: Depreciation
$55,000.00
$55,000.00
$55,000.00
Add: Recovery of NWC
$0.00
$0.00
$286,000.00
Add: After Tax Salvage Value of Machine
$0.00
$0.00
$23,100.00
OCF
-$11,800.00
-$2,925.00
$308,837.50
Depreciation = $165,000/3 = $55,000
Change in NWC = 20% of sales of the year (Cash Outflow)
Recovery of NWC = Sum of NWC every year at the end of project (Cash Inflow)
After Tax Salvage Value = Market Value X (1-tax rate) => $35,000 x 0.66 = $23,100
Year
1
2
3
Units Sold
$1,000.00
$1,250.00
$1,325.00
Sales
$400,000.00
$500,000.00
$530,000.00
Less: Variable Cost
$225,000.00
$281,250.00
$298,125.00
Less: Fixed Cost
$100,000.00
$100,000.00
$100,000.00
Less: Depreciation
$55,000.00
$55,000.00
$55,000.00
EBIT
$20,000.00
$63,750.00
$76,875.00
Less: tax @ 34%
$6,800.00
$21,675.00
$26,137.50
Net Income
$13,200.00
$42,075.00
$50,737.50
Add: Change in NWC
-$80,000.00
-$100,000.00
-$106,000.00
Add: Depreciation
$55,000.00
$55,000.00
$55,000.00
Add: Recovery of NWC
$0.00
$0.00
$286,000.00
Add: After Tax Salvage Value of Machine
$0.00
$0.00
$23,100.00
OCF
-$11,800.00
-$2,925.00
$308,837.50
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