1. **Problem Statement:** Estimate the annual net cash flows for the project considering revenues, costs, taxes, depreciation, working capital changes, and salvage value. 2. **Formulas and Important Rules:** - Revenue = Units Sold \times Selling Price - Variable Cost = Units Sold \times Variable Cost per Unit - Contribution = Revenue - Variable Cost - Fixed Costs - Depreciation = Machine Cost / Life - Taxable Income = Contribution - Depreciation - Tax = Taxable Income \times Tax Rate - Net Income = Taxable Income - Tax - Operating Cash Flow = Net Income + Depreciation - Change in Working Capital = 5% of Annual Sales - Previous Year Working Capital - Net Cash Flow = Operating Cash Flow - Change in Working Capital - Initial Investment includes Machine Cost + Initial Stocking + Initial Working Capital - Salvage Value is added in final year cash flow 3. **Step-by-step Calculation:** **Given:** - Machine Cost = 600000 - Life = 5 years - Resale Value = 60000 - Initial Stocking = 40000 - Initial Working Capital = 30000 - Fixed Costs = 50000 - Tax Rate = 0.25 - Depreciation = 600000 / 5 = 120000 per year - Working Capital = 5% of sales each year **Year 1:** - Revenue = 5000 \times 120 = 600000 - Variable Cost = 5000 \times 90 = 450000 - Contribution = 600000 - 450000 - 50000 = 100000 - Taxable Income = 100000 - 120000 = -20000 (loss, so tax = 0) - Net Income = -20000 - Operating Cash Flow = -20000 + 120000 = 100000 - Working Capital = 5% \times 600000 = 30000 - Change in WC = 30000 - 30000 (initial) = 0 - Net Cash Flow = 100000 - 0 = 100000 **Year 2:** - Revenue = 5500 \times 125 = 687500 - Variable Cost = 5500 \times 93 = 511500 - Contribution = 687500 - 511500 - 50000 = 126000 - Taxable Income = 126000 - 120000 = 6000 - Tax = 6000 \times 0.25 = 1500 - Net Income = 6000 - 1500 = 4500 - Operating Cash Flow = 4500 + 120000 = 124500 - Working Capital = 5% \times 687500 = 34375 - Change in WC = 34375 - 30000 = 4375 - Net Cash Flow = 124500 - 4375 = 120125 **Year 3:** - Revenue = 6000 \times 130 = 780000 - Variable Cost = 6000 \times 95 = 570000 - Contribution = 780000 - 570000 - 50000 = 160000 - Taxable Income = 160000 - 120000 = 40000 - Tax = 40000 \times 0.25 = 10000 - Net Income = 40000 - 10000 = 30000 - Operating Cash Flow = 30000 + 120000 = 150000 - Working Capital = 5% \times 780000 = 39000 - Change in WC = 39000 - 34375 = 4625 - Net Cash Flow = 150000 - 4625 = 145375 **Year 4:** - Revenue = 6500 \times 135 = 877500 - Variable Cost = 6500 \times 100 = 650000 - Contribution = 877500 - 650000 - 50000 = 177500 - Taxable Income = 177500 - 120000 = 57500 - Tax = 57500 \times 0.25 = 14375 - Net Income = 57500 - 14375 = 43125 - Operating Cash Flow = 43125 + 120000 = 163125 - Working Capital = 5% \times 877500 = 43875 - Change in WC = 43875 - 39000 = 4875 - Net Cash Flow = 163125 - 4875 = 158250 **Year 5:** - Revenue = 7000 \times 140 = 980000 - Variable Cost = 7000 \times 100 = 700000 - Contribution = 980000 - 700000 - 50000 = 230000 - Taxable Income = 230000 - 120000 = 110000 - Tax = 110000 \times 0.25 = 27500 - Net Income = 110000 - 27500 = 82500 - Operating Cash Flow = 82500 + 120000 = 202500 - Working Capital = 5% \times 980000 = 49000 - Change in WC = 49000 - 43875 = 6125 - Net Cash Flow before salvage = 202500 - 6125 = 196375 - Add Salvage Value = 60000 - Recover Working Capital = 49000 - Total Net Cash Flow Year 5 = 196375 + 60000 + 49000 = 305375 4. **Summary of Annual Net Cash Flows:** - Year 0 (Initial Investment): - (600000 + 40000 + 30000) = -670000 - Year 1: 100000 - Year 2: 120125 - Year 3: 145375 - Year 4: 158250 - Year 5: 305375 **Final answer:** Annual net cash flows are as above for years 1 to 5, with initial investment at year 0.