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Sir i hope you are doing very well. I have a question for incremental costs.
Do we always take working capital costs as incremental? What exactly is incremental and why do we take it? Why do we calculate it like that?
For Example in in Paper June 2013 question 1 The question gives us working capital with inflation and doesnt mention anything about incremental still they are taken as incremental working capital do we always have to do that? Whereas there were incremental fixed costs but they werent charged like incremental? And also fixed costs are only taken if mentioned right? how do we differentiate when to take fixed costs when to not?
I hope my question is understandable to you 😛
Thanks in advance 🙂
Incremental means extra, and we are always interested in the extra cash flows (and only the extra cash flows) that result from doing a project.
So if extra working capital is needed, then it is relevant.With regard to fixed costs we are only interested if there are extra fixed costs – i.e. if the total fixed costs of the business change. If they do change then the extra is relevant.
I do suggest that you watch our free lectures on investment appraisal where this is explained.
Our free lectures are a complete course for Paper F9 and cover everything needed to be able to pass the exam well.Thank You So Much For Your Reply.
Sir But thn do we always assume working capital to be incremental and calculate it that way? Like in question of June 2013? Can u please explain to me with regard of this question why the incremental fixed costs are not calculated in such manner? and working capital is calculated that way?
I cannot find explanation for incremental working capital in the lectures can u please guide where can i look for it?
Thanks a lot 🙂
Sir I went through your lectures again and no where it explains Incremental working capital. In Your Example 2 of working capital it says an additional working capital of $20,000 will be required and you just charged it very straightforward no extra or incremental. and same thing is said in June 2013 question 1 where it says Initial Investment in working capital of $500,000 will be required. That has been calculated in the incremntal way?
Whats the difference between both? why one is stragiht forward and other exam question is different calculation?
It is bit confusing.
My request is to please add a video explaing incremental working capital and how we solve this question as its too standard.
Otherwise if u can explain it to me here Please.Thank You So much for your help.
The question says that working capital of 500,000 is needed initially. It also says that working capital is subject to inflation of 4.7% a year.
Therefore 500,000 is needed at time 0. Also though they will automatically need an extra 4.7% of 500,000 = 23,500 at time 1, because of inflation.
This means that at time 1 the total working capital will now be 500,000 + 23,500 = 523,500.
Again, however, because of inflation they will need an extra 4.7% x 523,500 = 24,605 at time 2.
The total working capital is now 523,500 + 24,605 = 548,105, and so on.With regard to the fixed costs, I think you have misunderstood the wording.
The question says that doing the project will need incremental (extra) fixed costs of 250,000 a year. This does not mean (ignoring inflation for the moment) that it is 250,000 in the first year, 500,000 in the second year, and so on. It simply means it is 250,000 higher every year. (If I told you that your salary is being increased by 250,000 a year, you would not assume that it would go up by an extra 250,000 next year as well 🙂 )Neither of these need an extra lecture. It is application of normal rules, and any problem is understand what is written in the question. The examiner can phrase it in lots of different ways and you can only get used to it by practicing every question in your Revision Kit.
Sir, So the difference between the example in course notes and this question is only inflation? Because the example of working capital in course note says ”In addition a further $20,000 working capital will be required at the start of the project” The start of the project also means initial investment means times 0? My confusion is that there is no mention of the word Incremental in the exam question same like in your example.
I am sorry if i sound too dumb:P
I am not saying to add a lecture on these issues What i am requesting is a lecture on Incremental working capital to clear this concept. i might be wrong and u will already be having the video of this lecture online but i couldnt find it, if u can guide me if its there.
Actly i am doing self study for this subject and i took off for a month now and i am giving only this exam in March. And all i am relying on are your lectures, course notes along with a exam kit and of course your guidance 🙂 It was recommended to me by many people and i really hope to pass this exam. I am giving my best. i will really like to thank you for giving all this help.
The start of the project is always time 0 (the start of the first year) and if working capital is required it is always first required at time 0, unless the question specifically says differently.
In this question therefore, there is an outflow of 500,000 for working capital at time 0 (just as in the example in my lecture).
The only reason in this exam question for extra working capital being needed in later years is because the question says that the working capital is subject to inflation.
Questions do not need to use the word incremental – we are always wanting all extra cash flows that will occur as a result of doing the project. Sometime the word incremental is used, but all it means is extra and so the examiner doesn’t have to use that specific word.
Thank You for that explanation Sir.
I am working through all past paper questions so that i will be confident in answering this issue.
Any suggestion in which paper can i can this particular issue? Till now i have done this thing only twice.
Thanks again. May God Bless You.
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