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 $160 per unit and sales volume to be 10,600 units in year 1; 25,600 units in year 2; and 5,600 units in year 3. The project has a 3 year life. Variable costs amount to $85 per unit and fixed costs are $206,000 per year. The project requires an initial investment of $342,000 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 $46,000. NWC requirements at the beginning of each year will be approximately 16% of the projected sales during the coming year. The tax rate is 30% and the required return on the project is 11%. What will the year 2 cash flows for this project be?

$1,600,000

$1,120,000

$850,000

$1,234,000

Explanation / Answer

Year 2

sales- COGS=25600*(160-85)=1920000

minus Fixed cost=1920000-206000=1714000

minus depreciation=1714000-114000=1600000

minus Add in NWC=1600000-16%*(25600-10600)*160=1216000

Minus tax=1216000*(1-0.3)=851200

PAT=851200

hence cash flow=PAT+depreciation- change in NWC=851200+114000-384000=581200

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