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Hello I have a problem understanding the working capital requirements. Below is the working capital statement from the question.
At the start of every year, the Uwa Project will need working capital. In the first year, this will be 20% of sales revenue.
In subsequent years, the project will require additional or a reduction in working capital of 10% for every $1 increase
or decrease in sales revenue respectively. The working capital is expected to be fully recovered when the Uwa Project
ceases.I dont really know how to do for the subsequent years and may you explain in details because in the answer, they dont provide clear explanations.
Thank you!
The revenue in the first year is 5,160. Therefore at the start of the first year (i.e. time 0) they need working capital of 20% x 5,160 = 1,032.
Had the question said nothing else, then they would hold that amount of working capital throughout the project and then as usual get it back as an inflow at the end of the project.
However here the question says that as the revenue increases or decreases the working capital needs to be increased or decreased.
The revenue in the second year increases by 24,883 – 5,160 = 19,723. Therefore the working capital needs to be increased by 10% x 19,723 = 1,971 at the start of the second year (i.e. time 1). It is the same arithmetic for each of the year until the final year when all of the working capital is recover in the normal way.
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