Expenses are expected to be 50% of revenues, and working capital required in eac

Question

Expenses are expected to be 50% of revenues, and working capital required in each year is expected to be 10% of revenues in the following year. The product requires an immediate investment of $50,000 in plant and equipment.

b.

If the plant and equipment are depreciated over 4 years to a salvage value of zero using straight-line depreciation, and the firm’s tax rate is 30%, what are the project cash flows in each year? (Enter your answers in thousands of dollars. Do not round intermediate calculations. Round your answers to 2 decimal places.)

Explanation / Answer

a) The initial investment = Investment in plant and equipment + working capital requirement of year 1

working capital requirement of year 1 = 10% of revenues of year 1

working capital requirement of year 1 = 0.10 * $ 54,000

working capital requirement of year 1 = $ 5400

Initial investment = $ 50,000 + $ 5400

Initial investment = $ 55,400

__________________________________________________________________

Depreciation per year = $ 50,000 / 4

Depreciation per year = $ 12,500

Total working capital requirements = 0.10 * $ 54,000 + 0.10 * $ 30,000 + 0.10 * $ 20,000 + 0.10 * $ 10,000

Total working capital requirements = $ 11,400

Cash flow in year 1 = ( Revenues - expenses - depreciation) * ( 1 - tax rate) + depreciation

Cash flow in year 1 = ( $ 54,000 - $ 27,000 - $ 12,500) ( 1 - 0.30) + $ 12,500

Cash flow in year 1 = $ 22,650

Cash flow in year 2 = ( $ 30,000 - $ 15,000 - $ 12,500) (1 - 0.30) + $ 12,500

Cash flow in year 2 = $ 14,250

Cash flow in year 3 = ( $ 20,000 - $ 10,000 - $ 12,500) ( 1- 0.30) + $ 12,500

Cash flow in year 3 = $ 10,750

Cash flow in year 4 = ( $ 10,000 - $ 5000 - $ 12,500) ( 1 - 0.30) + $ 12,500 + Net working capital

Cash flow in year 4 = $ 18,650

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