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Hello tutor, I’ve been trying to do a number on working capital-relevant cash flows however I reached a point where I got confused. Below is how the question read;
Sales of a new product are forecast at $100,000 in the first year, increasing by a 10% compound rate per annum. The product has a four-year life cycle. Working capital equal to 15% of annual sales is required at the start of each year. The company’s contribution margin is 40% and no incremental fixed costs are expected.You are required to determine cash flows for each year.
My question is when you are forecasting working capital do you start from T0 or T1. For example 10% of annual sales forT1 is $15,000 and since working capital is required at the start of each year do I say working capital in T1 is $ 15,000? or the $15,000 would be working capital for T0?
I really need a clarification on this. Thanks
T0, T1 etc are not years – they are points in time that are one year apart.
So T0 is the start of the first year; T1 is the end of the first year/start of the second year; T1 is the end of the second year/start of the third year; and so on.
For most flows (such as sales revenue; cost of materials etc.) we always assume that they occur at the ends of year. So the first years revenue occurs at T1, the second years revenue occurs at T2 etc..
However, when working capital is required at the start of the year (as is virtually always the case in the exam), the first years working capital is at T0. If any more is required for the second year then it is at T1 and so on.
You will find the free lecture on relevant cash flows for investment appraisal useful.
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