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 $400 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 $225 per unit and fixed costs are $100,000 per year. The project requires an initial investment of $165,000 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 $35,000. NWC requirements at the beginning of each year will be approximately 20 per cent of the projected sales during the coming year. The tax rate is 34 per cent and the required return on the project is 10 per cent. What will the cash flows for this project be?

cash flow year 0 = -$245,000

cash flow year 1 = $82,700

cash flow year 2 = $157,075

cash flow year 3 = $300,837.50

Explanation:

expected sales year 1 = $400,000

expected sales year 2 = $500,000

expected sales year 3 = $530,000

initial investment = $-165,000

NWC increase for end of year 0 = -$80,000

NWC increase for end of year 1 = -$20,000

NWC increase for end of year 2 = -$6,000

NWC recovered at end of year 3 = $106,000

contribution margin per racket = $400 - $225 = $175

fixed cost per year = $100,000

depreciation rate per year = $165,000 / 3 = $55,000

after tax salvage value = $35,000 - ($35,000 x 34%) = $23,100

cash flow year 0 = -$165,000 - $80,000 = -$245,000

cash flow year 1 = {[(1,000 x $175) - $55,000] x 66%} + $55,000 - $20,000 = $82,700

cash flow year 2 = {[(1,250 x $175) - $55,000] x 66%} + $55,000 - $6,000 = $157,075

cash flow year 3 = {[(1,325 x $175) - $55,000] x 66%} + $55,000 + $106,000 + $23,100 = $300,837.50

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