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Dear Sir,
Refer to Q2 Mar/June 2018 – Part Info as below: –
The new facilities will also require an immediate initial investment in working capital of $3 million. Working capital requirements will increase by the rate of inflation for the next three years and any working capital at the start of Year 4 will be assumed to be released at the end of the appraisal period.
Predicted inflation rates are as follows:
Year 1 2 3 4
8% 6% 5% 4%:Why the working capital requirement yearly increased of cash flows are not as follow: –
Cash flows will be increased by rate of inflation% to ,
3M x 1.08 (Year 1) = 3.24M
3M x 1.08 x 1.06 (Year 2), = 3.434M
3M x 1.08x 1.06 x 1.05 (Year 3) = 3.606MInstead just work out as “incremental WC” only …
3M x 0.08 = 240K (Year 1)
3.24M x 0.06 =194K (Year 2)
3.4344M x 0.05 = 172K (Year 3).Thanks in advance for clarification .
This is an AFM question not APM. However…..
When project is started all of the initial WC must be supplied. It can be helpful to think of it being purely inventory. Lets say $100m is of inventory is needed to allow operations to be carried out, so there is an immediate cash outflow of $100m. That inventory level is maintained the whole year being replenished by purchases as sales eat into it. So, at the end of the year $100m is still locked up inventory
If the WC for the next year is 10% higher, then the inventory needs to be $110m, but there is already $100m there in closing/opening inventory so only another $10m needs to be spent on topping up inventory for that year.
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