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 $490 per unit and sales volume to be 1,200 units in year 1; 1,125 units in year 2; and 1,000 units in year 3. The project has a 3-year life. Variable costs amount to $270 per unit and fixed costs are $100,000 per year. The project requires an initial investment of $138,000 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 $26,000. NWC requirements at the beginning of each year will be approximately 30 percent of the projected change in sales during the coming year. The tax rate is 35 percent and the required return on the project is 11 percent.

What change in NWC occurs at the end of year 1?

Explanation / Answer

Net Working capital (NWC) is 30% of the projected change in sales of the following year.

Change in sales at the beginning of year 1 = 1000 units of year 1 - 0 units of previous year = 1000 units

Change in sales at the end of year 1 = 1125 units of year 2 - 1000 units of year 1 = 125 units

NWC at the beginning of year 1 = 1000 x $490 x 30% = $147,000

NWC at the end of year 1 = 125 x $490 x 30% = $18,375

Therefore, NWC would decrease by $147000 - $18375 = $128,625

what would have happended to NWC if this was NWC was 30% of project sales instead of change in sales?

In that case, NWC would increase by $18375 as sales increase by 125 units.

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