Question

The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30,000 and the machine will be depreciated straight line over its three-year life to a residual value of $0.

The cane manufacturing machine will result in sales of 2000 canes in year 1. Sales are estimated to grow by 10% per year each year through year three. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a cost per unit to manufacture of $9 each.

Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the 35% tax bracket, and has a cost of capital of 10%.

The change in Net working capital from year one to year two is closest to:

Answer 1

Year 1 sales = 2000 units

revenue = 2000 * 18 = 36000

Working capital = current assets - Current liabilities

= (2% + 4% + 9%) - 5%

= 10% of sales

Year 1 working capital = 36000*10% = 3600

Year 2 sales = 2000 * (1+10%) = 2200

Revenue = 2200 * 18 = 39600

Working capital = 39600 * 10% = 3960

Change = 3960 - 3600 = $360

so working capital increases by $360