Question

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 $380 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 $215 per unit and fixed costs are $100,000 per year. The project requires an initial investment of $159,000 in assets, which will be depreciated on a straight-line basis with a life of 3 years. The actual market value of these assets at the end of year 3 is expected to be $33,000. 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 39 percent and the required return on the project is 10 percent. (Use Table 12.7 What will the cash flows for this project be? (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places.) Year Total cash flow s (235,000.00)

Answer 1

Year 1 Sale value = $380 * 1000 units = $380,000

Year 2 Sale value = $380 * 1250 units = $475,000

Year 3 Sale value = $380 * 1325 units = $503,500

Year 1 Variable cost = $215 * 1000 units = $215,000

Year 2 Variable cost = $215 * 1250 units = $268,750

Year 3 Variable cost = $215 * 1325 units = $284,875

Fixed cost per year = $100,000

Initial investment = $159,000

Depreciation per year = ($159,000 - $33,000)/3 = $42,000

Net working capital year 0 = $380,000 * 20% = $76,000

Net working capital year 1 = $475,000 * 20% = $95,000

Excess required = $95000 - $76000 = $19000

Net working capital year 2 = $503,500 *20% = $100,700

Excess required = $100700 - $ 95000 = $5700

YEAR	0	1	2	3
Initial investment	($159,000)
Sales		$380,000	$475,000	$503,500
(-) Variable cost		($215,000)	($268,750)	($284,875)
(-) Fixed cost		($100,000)	($100,000)	($100,000)
(-) Depreciation		($42,000)	($42,000)	($42,000)
Profit before tax		$23,000	$64,250	$76,625
(-)Tax @ 39%		($8,970)	($25,057.50)	($29,883.75)
Profit after tax		$14,030	$39,192.50	$46,741.25
+ Depreciation		$42,000	$42,000	$42,000
Cash flow after tax		$56,030	$81,192.50	$88,741.25
+Salvage value				$33,000
+/(-) Net working capital	($76,000)	($19,000)	($5,700)	$100,700
Total cash flow	($235,000)	$37,030	$75,492.50	$222,441.25

Note : Since there will be no profit on sale of investment, there will be no tax effect on Salvage value received.