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Next, we compute the depreciation on the \$800,000 investment in Table 10.10. With this information, we can prepare the pro forma income statements, as shown in Table 10.11. From here, computing the operating cash flows is straightforward. The results are illustrated in the first part of Table 10.13.

Change in NWC Now that we have the operating cash flows, we need to determine the changes in NWC. By assumption, net working capital requirements change as sales change. In each year, MMCC will generally either add to or recover some of its project net working capital. Recalling that NWC starts out at \$20,000 and then rises to 15 percent of sales, we can calculate the amount of NWC for each year as illustrated in Table 10.12.

As illustrated, during the first year, net working capital grows from \$20,000 to .15 X \$360,000 = \$54,000. The increase in net working capital for the year is thus \$54,000 -20,000 = \$34,000. The remaining figures are calculated in the same way.

Remember that an increase in net working capital is a cash outflow, so we use a negative sign in this table to indicate an additional investment that the firm makes in net working capital. A positive sign represents net working capital returning to the firm. Thus, for example, \$16,500 in NWC flows back to the firm in Year 6. Over the project's life, net working capital builds to a peak of \$108,000 and declines from there as sales begin to drop off.

We show the result for changes in net working capital in the second part of Table 10.13. Notice that at the end of the project's life, there is \$49,500 in net working capital still to be recovered. Therefore, in the last year, the project returns \$16,500 of NWC during the year and then returns the remaining \$49,500 at the end of the year for a total of \$66,000.

Capital Spending Finally, we have to account for the long-term capital invested in the project. In this case, MMCC invests \$800,000 at Year 0. By assumption, this equipment will be worth \$160,000 at the end of the project. It will have a book value of zero at that time. As we discussed earlier, this \$160,000 excess of market value over book value is taxable, so the aftertax proceeds will be \$160,000 X (1 - .34) = \$105,600. These figures are shown in the third part of Table 10.13.

Ross et al.: Fundamentals I IV. Capital Budgeting I 10. Making Capital I I © The McGraw-Hill of Corporate Finance, Sixth Investment Decisions Companies, 2002

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