Question

You are evaluating a project for your company. You estimate the sales price to be $50 per unit and sales volume to be $5,000 units in year 1; 10,000 units in year 2; and 2,500 units in year 3. The project has a three-year life. Variable costs amount to $10 per unit and fixed costs are $75,000 per year. The project requires an initial investment of $25,000 in assets that 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 $5,000. 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 34% and the required return on the project is 13 percent. What change in NWC occurs at the end of year 1?
       a. $13,000
       b. $34,000
       c. $50,000
       d. $75,000

Answer 1

The answer is option c. $50,000

Explanation and calculation:

NWC required at the beginning of year 1 = 20% of sales during year 1

= 20% of (5000 units * $50 per unit)

= $50,000

NWC required at the beginning of year 2 (or end of year 1) = 20% of sales during year 2

= 20% of (10,000 units * $50 per unit)

= $100,000

Thus changes in NWC that occurs at the end of year 1 = 100,000 - 50,000

= $50,000