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 $440 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 $245 per unit and fixed costs are $100,000 per year. The project requires an initial investment of $177,000 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 $39,000. NWC requirements at the beginning of each year will be approximately 20 percent of the projected sales during the coming year. The tax rate is 35 percent and the required return on the project is 11 percent. (Use SL depreciation table)

What will the cash flows for this project be? (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Round your final answers to 2 decimal places.)

Year	0		1		2		3
Total cash flow	$		$		$		$

Answer 1

Year Total Cash flow Year 0 Year 1 Year 2 Year 3 $(265,000.00) $ 60,400.00 $ 107,487.50 $ 265,543.75

Workings:

Year Initial Investment Cash Flows from operation Depreciation Tax shield Net Working Capital Cash flows from Sale of asset Total Cash flow Year 0 Year 1 Year 2 Year 3 (177,000.00) 61,750.00 93,437.50 102,943.75 20,650.00 20,650.00 20,650.00 (88,000.00) (22,000.00) (6,600.00) 116,600.00 25,350.00 (265,000.00) 60,400.00 107,487.50 265,543.75

Cash Flows from operation Year 1 Year 2 Sale Price per unit 440 440 Sales units 1,000 1,250 Sales 440,000 550,000 Less: Variable Costs (Sale units * 245) 245,000 306,250 Less: Fixed Costs 100,000 100,000 Cash Flows from operation 95,000 143,750 Tax @ 35% 33,250.00 50,312.50 Cash Flows after tax 61,750.00 93,437.50 Year 3 440 1,325 583,000 324,625 100,000 158,375 55,431.25 102,943.75

Calculation of cash flow for net working captial Year 1 Year 2 Year 3 440,000 550,000 | 583,000 20 % on Sales 88,000 110,000 116,600 Cash flow 88,000 22,000 6,600 Sales

Working capital invested will be released at the end of the project.

177,000 Tax Shield on depreciation Cost of Asset Useful life Depreciation Tax Rate Tax Shield 59,000 35% 20,650

Cash flow from sale of asset Since book value is zero, whole amount is taxable Market value Asset 39000 Tax Rate 35% 13650 Cash flow after tax 25350 |Тах