Question

User sales for year 2 of a new project are expected to increase by 10%. current assets (inventory accounts receivable) are expected to increase by 17% for every dollar increase in sales while accounts payable are expected to increase by 6%. for year 2 the change in cash flows due to working capital will be:

a. -1.1% of sales.
b. 10% of sales.
c. -10% of sales.
d. 1.1% of sales.

Answer 1

The correct answer is a. -1.1% of sales; this represents the net change in cash flows due to working capital, resulting from a 10% increase in sales for year 2 of the project.

Step-by-step explanation:

The student is asking about the change in cash flows due to working capital changes when sales are expected to increase by 10%. If current assets increase by 17% for every dollar increase in sales and accounts payable increase by 6%, the net change in working capital for every dollar increase in sales would be 17% - 6% = 11%. Therefore, for year 2, the change in cash flows due to working capital would be a negative 11% of the sales increase, since working capital investments are an outflow. If sales are increasing by 10%, and the working capital change is 11% of that increase, the overall impact on cash flow would be -1.1% of sales (10% sales increase x 11% working capital change). Thus, the correct answer is a. -1.1% of sales.