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Q: Finance ( Answered 5 out of 5 stars,   0 Comments )
Subject: Finance
Category: Business and Money > Finance
Asked by: baseball2-ga
List Price: $10.00
Posted: 25 Jul 2005 17:53 PDT
Expires: 24 Aug 2005 17:53 PDT
Question ID: 547862
Need help with a formula.

The information I have is:

Year            Unit Sales
1                 22,000
2                 30,000
3                 14,000
4                  5,000
Thereafter          0

Working capital will amount to 20% of sales in the following year.
Plant and equipment will require an investment of 200,000. THis
investment will depreciated using MACRS and a 3 year life. AFter 4
years, the equipment will have an economic and book value of zero. The
firm's tax rate is 35%. The dicount rate is 20% How do I calculate the
value project?

Request for Question Clarification by omnivorous-ga on 26 Jul 2005 06:52 PDT
Baseball2 --

You're missing one piece of information to solve this: the sales price
per unit, which will allow you to calculate revenues and cash flow.

Also, be sure to recapture your working capital in year 4.

Best regards,


Request for Question Clarification by omnivorous-ga on 26 Jul 2005 08:03 PDT
Baseball2 --

I started to set up this problem (even without price/unit) and
realized that there's probably also a variable cost/unit that's

Best regards,


Clarification of Question by baseball2-ga on 26 Jul 2005 08:14 PDT
I am so sorry. The following table that I gave you respresents sales
forcast for a specific company. The unit price is 40.00 and the unit
cost of the items is 25.00. Hope this helps!
Subject: Re: Finance
Answered By: omnivorous-ga on 26 Jul 2005 09:10 PDT
Rated:5 out of 5 stars
Baseball2 ?

The tricky part of this whole problem is actually in the working
capital (WC) consumption. As a result, I?ve set up a spreadsheet with
two sections ? one on PROFITS and one on CASH FLOW.  This is similar
to the cash budgeting process that a company would follow ? setting up
income and expense budgets, then calculating cash consumption ? so in
that sense it?s very realistic.

Now, I?ll take you through the spreadsheet linked below, line-by-line:


Line3: we use the ?Year 0? convention for upfront costs.  Note that we
have to put our first year?s working capital requirements in here when
we get to cash flow.
Line4: units
Line5: units * $40 to get Revenues

Line7: gross profit can be figured with the contribution ($15) * units
Line8: depreciation, using the half-year Modified ACRS tables for 3-year assets

The modified ACRS depreciation for a 3-year property based on the
half-year convention are:
Year 1: 33.33%
Year 2: 44.45%
Year 3: 14.81%
Year 4: 7.41%
?Depreciation Tables?

Line9: profit before tax, which we?re calculating in order to be able
to figure taxes
Line11: taxes (at 35%)

It?s not necessary to figure the actual accounting profit here, as the
value of a project is in its cash flow.  We could figure the net
profits and add back depreciation but it?s really a useless step.


Line15: our initial capital investment

Line17: depreciation doesn?t use cash, so the ?Gross Profits? line
shows cash coming in ? except for the taxes that we?ll pay each year
Line18: one of the two inevitables of modern life: taxes (as the joke
goes, the other is ?death?)
Line19: here?s where we have to account for the working capital (WC)
being used to buy materials for next year?s production
Line20: each year WC is slightly different.  It all gets consumed in
year 0 as you invest in raw materials or work-in-process ? but after
year 0 you are asking yourself whether it?s going up?  Or down?  If
it?s going up, we?re spending $$ on working capital ? if it?s going
down cash is freed.

Line22: Gross Profits + taxes + change in WC  (I?ve used red for
negatives everywhere so it?s obvious what charges are for cash going

Line24: NPV factor, which as you know, is calculated by:
Year 1: 1/(1.2)
Year 2: 1/(1.2)^2
Year 3: 1/(1.2)^3
Year 4: 1/(1.2)^4

Line26: discounted cash flow ? including the total for the project. 
At $254,441 in positive discounted cash flow, this project would be a
go despite the high discount rate of 20%.

Google search strategy:
MACRS + depreciation + percentage

Search IRS site for:
Modified ACRS + depreciation

Best regards,

baseball2-ga rated this answer:5 out of 5 stars
As always a job well done. Thanks so much!

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