Problem 12-11 Operating Cash Flow (LG12-3) You are evaluating a project for The
ID: 2783851 • Letter: P
Question
Problem 12-11 Operating Cash Flow (LG12-3)
You are evaluating a project for The Tiff-any golf club, guaranteed to correct that nasty slice. You estimate the sales price of The Tiff-any to be $430 per unit and sales volume to be 1,000 units in year 1; 1,500 units in year 2; and 1,325 units in year 3. The project has a 3-year life. Variable costs amount to $240 per unit and fixed costs are $100,000 per year. The project requires an initial investment of $174,000 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 $38,000. 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.
You are evaluating a project for The Tiff-any golf club, guaranteed to correct that nasty slice. You estimate the sales price of The Tiff-any to be $430 per unit and sales volume to be 1,000 units in year 1; 1,500 units in year 2; and 1,325 units in year 3. The project has a 3-year life. Variable costs amount to $240 per unit and fixed costs are $100,000 per year. The project requires an initial investment of $174,000 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 $38,000. 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.
Explanation / Answer
Calculation of operating cash flow in Year 2 Sales (1500 units * $430) $645,000 Less : Variable costs (1500 units * $240) $360,000 Less: Fixed Costs $100,000 Less : Depreciation $45,333 Profit before tax $139,667 Less : Tax @ 34% $47,487 Net Income $92,180 Add : Depreciation $45,333 Less : Additional net working capital $43,000 Operating Cash flow for Year 2 $94,513 Depreciation per year using straight line method = (Cost - salvage value) / Useful life Depreciation per year using straight line method = ($174000 - $38000)/3 years = $45333 Additional working capital requirement in Year 2 = Working capital for Year 2 - Working capital for Year 1 Additional working capital requirement in Year 2 = (1500 units * $430 * 20%) - (1000 units * $430 * 20%) = $43000