For the following question answer, why was the Net working capital of $35,000 added to the OCF on year 5? The question had an initial net working capital of $35,000 for year 0 but I don't understand why it is recovered in year 5 (it was what was missing in my original answer)

Thanks

Answer

• NPV of the project = 18991.23
• Yes you should pursue the project, since NPV is positive

Explanation:

Annual Depreciation = (Cost-Salvage Value)/Useful life

Annual Depreciation = (175000-0)/5

Annual Depreciation = 35000

Initial Cost = -Equipment cost - net working capital.

Initial Cost = -175000 - 35000

Initial Cost = -210000

Cash Flow in year 1 = ((Sale Price- Variable cost)*No of unit-Fixed Cost)*(1-tax rate) + Annual Depreciation * Tax rate

Cash Flow in year 1 = ((56-32)*7500- 95000)*(1-35%) + 35000*35%

Cash Flow in year 1 = 67500

Cash Flow in year 2 = ((Sale Price- Variable cost)*No of unit-Fixed Cost)*(1-tax rate) + Annual Depreciation * Tax rate

Cash Flow in year 2 = ((56-32)*7500*(1+5%)- 95000)*(1-35%) + 35000*35%

Cash Flow in year 2 =73350

Cash Flow in year 3 = ((Sale Price- Variable cost)*No of unit-Fixed Cost)*(1-tax rate) + Annual Depreciation * Tax rate

Cash Flow in year 3 = ((56-32)*7500*(1+5%)^2- 95000)*(1-35%) + 35000*35%

Cash Flow in year 3 = 79492.50

Cash Flow in year 4 = ((Sale Price- Variable cost)*No of unit-Fixed Cost)*(1-tax rate) + Annual Depreciation * Tax rate

Cash Flow in year 4 = ((56-32)*7500*(1+5%)^3- 95000)*(1-35%) + 35000*35%

Cash Flow in year 4 = 85942.125

Cash Flow in year 5 = ((Sale Price- Variable cost)*No of unit-Fixed Cost)*(1-tax rate) + Annual Depreciation * Tax rate + Working capital Recovered

Cash Flow in year 5 = ((56-32)*7500*(1+5%)^4- 95000)*(1-35%) + 35000*35% + 35000

Cash Flow in year 5 = 127714.23125

NPV of the project = Initial Cost + PV of Future cash flow

NPV of the project = -210000 + (67500/1.23 + 73350/1.23^2 + 79492.50/1.23^3 + 85942.125/1.23^4 + 127714.23125/1.23^5)

NPV of the project = 18991.23