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 $150 per unit and sales volume to be 10,500 units in year 1: 25,500 units in year 2: and 5,500 units in year 3. The project has a 3 year life. Variable costs amount to $75 per unit and fixed costs are $205,000 per year. The project requires an initial investment of $339,000 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 $45,000. NWC requirements at the beginning of each year will be approximately 15% of the projected sales during the coming year. The tax rate is 35% and the required return on the project is 12%, what will the year 2 cash flows for this project be? $1,036.425 O $1149.425 O $811925 $1,594.500

Explanation / Answer

1) Answer (B) $1,149,425

Calculation :

Earnings before Depreciation and taxes .= Sales - (Variable costs + Fixed costs)

= (25,500*$150) - ((25,500*$75)+$205,000)

= $3,825,000 - ($1,912,500+$205,000)

= $1,707,500

Annual depreciation = $339,000 / 3 years

= $113,000

Earnings before tax = EBDT - Depreciation

= $1,707,500 - $113,000

= $1,594,500

Earnins After taxes = EBT - Tax

= $1,594,500 - ($1,594,500*35%)

= $1,036,425

Cash flow in the 2nd year = EAT + Depreciation

= $1,036,425 + $113,000

= $1,149,425

Since depreciation is non cash expenditure it shall be considered only for tax purposes.

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