You are evaluating a project for The Ultimate recreational tennis racket, guaranteed to correct that wimpy backhand. You estimate the sales price of The Ultimate to be $400 and sales volume to be 1,000 units in year 1, 1,250 units in year 2, and 1,325 units in year 3. The project has a three year life. Variable costs amount to $225 per unit and fixed costs are $100,000 per year. The project requires an initial investment of $165,000 which is depreciated straight-line to zero over the three year project life. The actual market value of the initial investment at the end of year 3 is $35,001. Initial net working capital investment is $75,000 and NWC will maintain a level equal to 20% of sales each year thereafter. The tax rate is 34% and the required return on the project is 10%. What is the operating cash flow for the project in year 2?

A) $26,400
B) $68,200
C) $97,075
D) $101,210
E) $105,738

Question

Gopi Kanth Nerella · Accepted Answer

Final Answer : C, Explanation :  To calculate the operating cash flow (OCF) for the project in year 2, we use the formula: OCF = (Sales - Costs - Depreciation) * (1 - Tax Rate) + Depreciation. For year 2: Sales = 1,250 units * $400/unit = $500,000. Variable Costs = 1,250 units * $225/unit = $281,250. Fixed Costs = $100,000. Depreciation = Initial Investment / Project Life = $165,000 / 3 = $55,000. Thus, Earnings Before Interest and Taxes (EBIT) = Sales - Variable Costs - Fixed Costs - Depreciation = $500,000 - $281,250 - $100,000 - $55,000 = $63,750. OCF = ($63,750) * (1 - 0.34) + $55,000 = $42,075 + $55,000 = $97,075.

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