Sales for year 2 of the new project are expected to increase by 10%. Current assets are expected to increase by 17% for every dollar increase in sales while accounts payable are expected to increase by 6%. For year 2 the change in cash flows due to working capital will be:
A) +10% of sales.
B) -10% of sales.
C) +1.1% of sales.
D) -1.1% of sales.

Question

Quizplus · Accepted Answer

The change in cash flows due to working capital is calculated by the increase in current assets minus the increase in accounts payable for every dollar increase in sales. With a 17% increase in current assets and a 6% increase in accounts payable for every dollar increase in sales, the net effect is an 11% increase in working capital needs for every dollar increase in sales. However, since this is an additional cost or use of cash, it results in a negative impact on cash flows, hence -11% of sales. Given the question specifies a 10% increase in sales, the change in cash flows due to working capital would be -1.1% of sales (10% of the 11% increase).

Sales for Year 2 of the New Project Are Expected