Question

you are evaluating a project for the farstroke golf club, guaranteed to correct that nasty slice. you estimate the sales price of the farstroke to be $440 per unit and sales volume to be 1,200 units in year 1; 1,325 units in year 2; and 1,000 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 $153,000 in assets, which 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 $31,000. nwc requirements at the beginning of each year will be approximately 30 percent of the projected sales during the coming year. the tax rate is 21 percent and the required return on the project is 12 percent. what is the operating cash flow for the project in year 2?

Answer 1

To calculate the operating cash flow for year 2, we need to calculate the following:

Revenue

Total Costs

Depreciation

Taxes

Operating Cash Flow

Revenue:

Revenue for year 2 is given as 1,325 units sold for $440 per unit:

Revenue = 1,325 × $440 = $583,000

Total Costs:

Total costs include variable costs and fixed costs. We are given a variable cost per unit of $245.

Variable costs = 1,325 × $245 = $324,625

Fixed costs = $100,000

Total costs = Variable costs + Fixed costs

Total costs = $324,625 + $100,000 = $424,625

Depreciation:

Because the project has a 3 years life therefore we have to multiply by 3

Depreciation = Asset cost / Project life

Depreciation = $153,000 / 3 = $51,000 per year

Taxes:

The tax rate is given as 21 per cent.

Taxable Income = Revenue - Total Costs - Depreciation

Taxable Income = $583,000 - $424,625 - $51,000 = $107,375

Taxes = Tax rate × Taxable income

Taxes = 0.21 × $107,375 = $22,548.75

Operating Cash Flow:

Operating cash flow is calculated as follows:

Operating Cash Flow = Earnings before interest and taxes (EBIT) × (1 - Tax rate) + Depreciation

EBIT = Revenue - Total Costs

EBIT = $583,000 - $424,625 = $158,375

Operating Cash Flow = $158,375 × (1 - 0.21) + $51,000

Operating Cash Flow = $158,375 × 0.79 + $51,000

Operating Cash Flow = $204,526.25

Therefore, the operating cash flow for the project in year 2 is $204,526.25.