Question

The Farmer Corporation is considering investing in a new manufacturing machine that has an estimated life of five years. The cost of the machine is $40,000 and the machine will be depreciated straight line over its five-year life to a residual value of $0. The manufacturing machine will result in sales of $50,000 in year 1. Sales are estimated to grow by 6% each year. It is estimated that the Farmer Corporation needs to hold 5% of its annual sales in cash, 10% of its annual sales in accounts receivable, 15% of its annual sales in inventory, and 20% of its annual sales in accounts payable. What is the required net working capital investment (changes in NWC) in the 2nd year for this project?

Multiple Choice

a) $300.

b) $5,000.

c) $2,500.

d) $5,300.

e) $150.

Answer 1

The required net working capital investment in the 2nd year for this project is d. $5,300.

To calculate the required net working capital (NWC) investment in the 2nd year for the project, we need to consider the changes in the components of working capital (cash, accounts receivable, inventory, and accounts payable) compared to the previous year.

Given the information provided, the sales in year 1 are $50,000, and they are estimated to grow by 6% each year. Therefore, the sales in the 2nd year would be:

Sales in 2nd year = Sales in 1st year + (Sales in 1st year × Growth rate)

Sales in 2nd year = $50,000 + ($50,000 × 0.06)

Sales in 2nd year = $50,000 + $3,000

Sales in 2nd year = $53,000

Now, let's calculate the changes in each component of working capital:

Change in cash = Sales in 2nd year × 5%

Change in accounts receivable = Sales in 2nd year × 10%

Change in inventory = Sales in 2nd year × 15%

Change in accounts payable = Sales in 2nd year × 20%

Plugging in the values:

Change in cash = $53,000 × 5% = $2,650

Change in accounts receivable = $53,000 × 10% = $5,300

Change in inventory = $53,000 × 15% = $7,950

Change in accounts payable = $53,000 × 20% = $10,600

The required net working capital investment in the 2nd year is the sum of these changes:

Required NWC investment = Change in cash + Change in accounts receivable + Change in inventory - Change in accounts payable

Required NWC investment = $2,650 + $5,300 + $7,950 - $10,600

Required NWC investment = $5,300

Therefore, the required net working capital investment in the 2nd year for this project is $5,300.

The answer is: d) $5,300.