You are evaluating a project for The Tiff-any golf club, guaranteed to correct t

Question

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 per unit = $645000

Variable cost = 1500 units * 240 per unit = $360000

Contribution = $645000-$360000 = $285000

Net profit before depreciation = Contribution - Fixed cost = $285000-$100000 = $185000

It is given that asset will be depreciated straight line to zero therefore depreciation per year = $174000/3 = $58000

Net profit = $185000 - $58000 = $127000

Net profit after tax = $127000 * (1-0.34) = $83820

Cash flow after tax = $83820+Depreciation = $83820+$58000 = $141820

Net working capital requirement in year 2 = 20% of 645000 = $129000

Net working capital of year 1 = 20% of (430*1000 units)= $86000

Therefore, cash introduced in year 2 for additional working capital = $129000 - $86000 = $43000

Therefore operating cash flow in year 2 = $141820 - $43000 = $98820

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