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Dear John,
My issue with this question has to do with the working capital (WC)
In paragraph 6 of the question, it says YR9,600 is needed for WC immediately, and that the working capital would be increased annually at the START of each of the next 3 years by Yilandwe’s inflation rate.
I have no difficulty finding the increases, but I do have a problem with the timing due to the following reason.
In investment appraisal cash flows are assumed to occur at the end of the period.
That is to say that a cash flow at the start of period 1, is assumed to occur at period 0. Similarly a cash flow at the start of period 2 is a period 1 flow, and so on.
If the above is true, then the treatment of the WC in this question is a bit inconsistent, and it got me confused.
Even though the increases occur at the START of the next 3 years, these were taken as the actual flows for those years, by the examiner.
I would have though that the increases for periods 1, 2,3, would be cash flows for periods 0, 1, 2 respectively (thus period 0 would have 9600+2112).
That should mean that the WC would be released in year 3 instead of year 4.
Is there anything I am not getting right?
Kind regards
The first year starts immediately (time 0) and finishes in 1 year time (time 1).
The second year starts in 1 years time (time 1) and finishes in 2 years time (time 2)
and so on.We assume operating flows occur at the ends of year (unless told otherwise) – so, for example, the revenue for the first year is at time 1, the revenue for the second year is at time 2, and so on.
Since working capital is needed at the start of each year, the first WC flow is at time 0, the second is at time 1 etc..
The working capital is recovered at the end of the projects life. Since here it lasts 4 year, the recovery is at time 4.
Thanks so much, Sir.
It would have been so much clearer for the examiner to just say it as you put it that, working capital is needed at the start of each year. What it meant was that one would have to understand those two sentences as meaning simply what you said.
Thank you once again
Regards
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