Question

You are evaluating a project for your company. You estimate the sales price to be $200 per unit and sales volume to be 3,000 units in year 1; 4,000 units in year 2; and 2,500 units in year 3. The project has a three-year life. Variable costs amount to $50 per unit and fixed costs are $150,000 per year. The project requires an initial investment of $200,000 in assets which will be depreciated straight-line to zero over the three-year project life. The actual market value of these assets at the end of year 3 is expected to be $30,000. NWC requirements at the beginning of each year will be approximately 10 percent of the projected sales during the coming year. The tax rate is 21 percent and the required return on the project is 10 percent. What is the operating cash flow for the project in year 2?

You are evaluating a product for your company. You estimate the sales price of product to be $140 per unit and sales volume to be 10,400 units in year 1; 25,400 units in year 2; and 5,400 units in year 3. The project has a 3 year life. Variable costs amount to $65 per unit and fixed costs are $204,000 per year. The project requires an initial investment of $336,000 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 $44,000. NWC requirements at the beginning of each year will be approximately 13% of the projected sales during the coming year. The tax rate is 21% and the required return on the project is 8%. What will the year 2 free cash flow for this project be?

Answer 1

1.

	Year 0	1st year	2nd Year	3rd Year
Sales price (a)		200	200	200
Variable Cost (b)		50	50	50
Contribution Margin (c =a-b)		150	150	150
Sales in unit (d)		3000	4000	2500
Total Contribution Margin (e = d*c)		450000	600000	375000
Fixed Cost (f)		150000	150000	150000
Depreciation Expense (g)		66666.67	66666.67	66666.67
Profit (h = e-f-g)		233333.3	383333.3	158333.3
Tax (i = h*21%)		49000	80500	33250
Net Profit (j = h-i)		184333.3	302833.3	125083.3
Cash Inflow (Net profit + Dep.)		251000	369500	191750
NWC required (10% * sales price * sales in units)	60000	80000	50000
Initial Investment	200000
Salvage Value				30000
Cash outflow (current NWC - Previous year NWC + investments if any)	260000	20000	-30000	-50000
Net Cash flow (cash Inflow + salvage value - cash outflow)	-260000	231000	399500	271750

Operating cash flow at the end of year 2 = $231,000

2.

	Year 0	1st year	2nd Year	3rd Year
Sales price (a)		140	140	140
Variable Cost (b)		65	65	65
Contribution Margin (c =a-b)		75	75	75
Sales in unit (d)		10400	25400	5400
Total Contribution Margin (e = d*c)		780000	1905000	405000
Fixed Cost (f)		204000	204000	204000
Depreciation Expense (g)		112000	112000	112000
Profit (h = e-f-g)		464000	1589000	89000
Tax (i = h*21%)		97440	333690	18690
Net Profit (j = h-i)		366560	1255310	70310
Cash inflow (Net profit + Dep.)		478560	1367310	182310
NWC required (13% * sales price * sales in units)	189280	462280	98280
Initial Investment	336000
Salvage Value				44000
Cash outflow (current NWC - Previous year NWC + investments if any)	525280	273000	-364000	-98280
Net Cash flow (cash flow + salvage value - cash outflow)	-525280	205560	1731310	324590

Free cash flow = Operating Cash flow - Capital Expenditure.

In 2nd year no capital expenditure takes place.

Free cash flow at the end of year 2 is $205,560.