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AW Co needs to have 100000 working capital in place immediately for the start of a 2 year project. The amount will stay constant in real terms. Inflation is running at 10% per annum, and AW Co’s money cost of capital is 12%.
What is the present value of the cash flows relating to working capital?
The need at outflow at time 0 of 100,000
At time 1 they need an extra outflow of 10% x 100,000 = 10,000 (because of the inflation).
At time 2, we assume than since the project will have finished they will get back all the working capital (unless the question says differently) and therefore have an inflow of 110,000.
You then calculate the PV of those flows in the normal way, discounting at the cost of capital of 12%.
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