Question

You are evaluating a project for The Ultimate recreational tennis racket, guaranteed to correct that wimpy backhand. You estimate the sales price of The Ultimate to be $490 per unit and sales volume to be 1,000 units in year 1; 1,250 units in year 2; and 1,325 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 $192,000 in assets, which will be depreciated on a straight-line basis with a life of 3 years. 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 25 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. (Use SL depreciation table) What will the cash flows for this project be for years 0-3?

Answer 1

Time line		0	1	2	3
Cost of new machine		-192000
Initial working capital	=next year unit sales*sales price*0.25	-122500
=Initial Investment outlay		-314500
Unit sales			1000	1250	1325
Profits	=no. of units sold * (sales price - variable cost)		220000	275000	291500
Fixed cost			-100000	-100000	-100000
-Depreciation	Cost of equipment/no. of years		-64000	-64000	-64000
-working capital to be maintained	=next year unit sales*sales price*0.25		-153125	-162313	0
=Pretax cash flows			-97125	-51312.5	127500
-taxes	=(Pretax cash flows)*(1-tax)		-64102.5	-33866.3	84150
+Depreciation			64000	64000	64000
=after tax operating cash flow			-102.5	30133.75	148150
reversal of working capital					437937.5
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				29040
+Tax shield on salvage book value	=Salvage value * tax rate				0
=Terminal year after tax cash flows					466977.5
Total Cash flow for the period		-314500	-102.5	30133.75	615127.5