Sir, i have a doubt in working capital being recovered. I didn’t get the logic. Is it that when the project generates profit, the amount invested is reaped back?

Have you not watched the free lectures on relevant cash flows for investment appraisal??

Working capital is needed to finance receivables, inventory etc.. It is needed for the duration of the project, but once the project finishes then the working capital is no longer needed and therefore the cash is recovered.

Thank You sir.. sir dividend are not tax allowable its meaning there is no tax saving on dividend Interest are tax allowable its mean there is tax saving on interest .

If you read the page before the test, it makes it clear that the test is selected at random from a large bank of questions – every time you attempt the test you are likely therefore to get different questions.

You can review your answers at the end of the test and see what the correct answers were.

As the page said, if you want workings for any of the questions then you need to copy the question in the Ask the Tutor Forum and I will explain.

inventory 1m cash 0.5m current liabilities 2.5 m current ratio 2.4 m sale 50 m (req) whayt is the recevble collection period ? plz solve this and show me workings

Current assets = cash+inventory+receivables Then receivables=current assets-inventory-cash Current ratio=current assets/current liabilities Then current assets=current ratio*current liabilities=2,4*2,5=6 Receivables=6-1-0,5=4,5 m Receivables collect period=receivables/sales*365= 4,5/50*365=32,85 days I guess I am right

Sonia: Did you not read my previous message? You must NOT post questions like this as comments on lectures – you must post them in the Ask the Tutor Forum.

But how can I understand that the examiner means that we need an extra working capital? I will try to explain what I mean: In example 4 chapter 8 of the course notes: “additional $200 of WC will be required at the start of the project”. Here we just add $200 at the the start and deduct it after 3 years. It’s clear for me. But in question 1 June 2013 of the past exam: “In addition to the initial cost of the new machinery, initial investment in working capital of $500,000 will be required. Investment in working capital will be subject to the general rate of inflation, which is expected to be 4路7% per year.” Here we add $500,000 in time 0 and do not deduct it at the end of the project (Machinery was replaced). Moreover during the project we deduct the amount above the $500,000 due to inflation.

I am a little bit confused about it. Could you help me?

Firstly, do not say we add working capital at the start and deduct it at the end. We investing working capital at the start and we received it at the end.

When there is inflation, extra working capital is needed each year to increase the level to that required.

In the December exam, the working capital is to be 10% of the revenue for the year, at the start of the year. So since the revenue in the first year is 1308.75, working capital is needed of 130.88 at the start of the first year – i.e. at time 0. The revenue in the second year is 2817.26 and so working capital is needed of 281.73 at the start of the second year – i.e. at time 1. However, there is already working capital of 130.88 and so only the additional 150.86 is required.

With regard to the recover at the end of the life of the project, there have only ever been two questions where the examiner did not recover it. In one question, you were specifically told in the question not to recover it. The other question was June 2013. The reason it was not recovered was that the question said that after the four years it would be replaced. The examiner therefore assumed that since the product would continue to be produced, the working capital would still be needed and would therefore not be recovered. However, he did accept that it was an unusual thing to assume and he said that full marks would be given if the working capital had been recovered (even though the final answer would be different).

In the exam therefore, always recover the working capital unless specifically told not to.

DEAR SIR, CONSIDERING THE TIME AVAILABLE, IS IT ALL THE TIME TO SHOW THE WOKINGS IN INVESTMENT APPRAISAL QUESTIONS AND IN SECTION A WHERE CALCULATIONS ARE ASKED?

In your lecture notes, chapter 7 investment appraisal, include DCF-NPV, DCF-IRR, ROCE-ARR and payback period. Chapter 10 investment appraisal under uncertainty, include sensitivity analysis, expected value, simulation and risk adjusted discount rat-CAMP. I’m bit confused, are there any connections between 2 chapters? All numbers in chapter 7 are estimated anyway, so they are not certain too. In exam, if I am asked to discuss and comment the investment appraisals, what things should I included? Thanks.

I am little bit confused while doing pass exam NPV questions, some of the model answer given show capital allowance, the tax saving as a negative figure in the calculation, but some are positive. I did notice they position the capital allowance figures differently in terms of its layout but other than this, any other reason why some are negative and some are positive? e.g. Jun 09 Q4 NPV question has the negative tax saving figures but here for this question has positive figure. Many thanks, Jing

Are you sure you mean June 2009? Question 4 was not a NPV question.

There are two ways that you can deal with capital allowances (both giving the same answer) and it is maybe this that is causing the confusion.

Suppose that in one year, the profit before allowances is 100, the capital allowances are 20, and the tax rate is 30%. No delay in the payment of tax.

One way is to calculate the taxable profit (100 – 20 = 80). Then calculate the tax payable (30% x 80 = 24), then the net cash flow (80 – 24 + 20 = 76). The 20 has been added back because it was not a cash flow – it was just needed for the tax calculations.

The other (easier and more common) way is to calculate the tax on the profit before allowances (100 x 30% = 30). Calculate the tax saved on allowances (20 x 30% = 6). And then calculate the net cash flow 100 – 30 + 6 = 76)

If you are asking about a different problem, then check which exam you are referring to and let me know.

Hi John, yes my mistake it was Jun 2008 Q4 that I was referring to. I realise that in Jun 08 Q4, the capital allowance did not include tax 30% as it was calculated as straight line, 1000/4 years = 250 a year. But the capital allowance in Dec 13 Q1 NPV question had included the tax when calculating the saving on reducing balance at 25%. Am I right to think that because in Jun 08 question, it did not include tax, therefore, it needs to be deducted before calculating the tax, reducing the taxable profit resulting in tax saving. However, in Dec 13, the tax had already been included the capital allowance calculation, so we need to add it back otherwise it would have been double counting?

In June 2008 he subtracted the CA’s to get the taxable profit, then he calculated the tax, then he added back the CA’s because they are not a cash flow.

In December 2013 he calculate the tax ignoring the CA’s and then separately calculated the tax saving on the CA’s.

You can always do it either way – they will give the same answer – but the December 2013 way is the easiest and safest.

If you are told the figures for the first year, then the flows at time 1 will not be inflated (but they will be for later years). If you are told that the flows are at current prices, then the flows at time 1 will be inflated (and inflated for each future year also).

You should watch my free lecture on Investment Appraisal with inflation and tax to see exactly what I mean.

I find it confusing on how to identify the correct year. Do you have any tips on this?

In the question it says “The level of working capital investment at the start of each year is expected to be 10% of the sales revenue in that year”. It seems to me it should be starting from year 1 because year 0 did not have any revenue?

It is time 0 (not year 0), time 1 (not year 1) and so on. They are points in time.

Suppose our year end is 31 December and we buy a machine on 1 January 2013.

Time 0 is 1/1/2013. The first year is year to 31/12/2013. We always assume that operating flows occur at the ends of year, and so the first revenue etc. occurs at 31/12/2013.

That is virtually one year from now (and it only matters because we are going to discount for one years interest), so 31/12/2013 is time 1.

So…..when it talks about the working capital at the start of each year, the start of the first year is 1/1/2013 – i.e. time 0. The start of the second year is 1/1/2014, which is one year from now – i.e. time 1.

And so on.

It will be worthwhile you watching my lecture on this.

Thanks John, I am watching your lectures on this now. If the question only says the initial investment in working capital of $XXX will be required, can I assume it will start from T1 since it did not say the working capital is required from the beginning of the year?

In most exam questions, the working capital is recovered at the end of the project.

However it depends on the question – if production is continuing, then the working capital will still be needed and is therefor not recovered.

(This was the case in Decembers exam. The question said that the machine would be replaced after four years. Obviously therefore, production was continuing. (Although the examiner did say that even if you had recovered the working capital, then you would still have been given full marks. ))

Suppose you were receiving 10,000 at current prices, receivable in one years time. Inflation is 5% and the nominal (actual) cost of capital is 15.5%.

You could either take the nominal approach and say that the actual cash flow will be 10,000 x 1.05, and then discount this cash flow at the actual cost of capital by multiplying by 1/1.155.

Alternatively you could take the ‘real’ approach and discount the real cash flow of 10,000 by the real cost of capital of 10% ((1.155/1.05) – 1)

Both would give exactly the same present value.

However, this only works when the number of years inflation is the same as the number of years of discounting (in my little example, 1 years inflation and 1 years discounting).

The problem referred to in the answer is that although this applies to the sales revenue, it does not apply to the working capital flows – for them there is always 1 years more inflation than the number of years that we are discounting.

I hope that helps.

(PS You will never need to discount at 15.5% in the exam – you will always be able to use tables. I only used 15.5% here to ‘prove’ it works 馃檪 )

When explaining why there are a difference between the nominal term and real term, the answer for Q1 (b) says “the working capital cash flows are timed differently to the sales income on which they depend, and so their inflation effects are timed differently to the related inflation effects in the discount rate.” What does this means?

umerr786 says

Excellent Lecture, makes it all seem so logical. Looking at the ACCA official answer for this question gave me a headache

John Moffat says

Thank you – I am please it helped you 馃檪

anonymous says

Sir, i have a doubt in working capital being recovered. I didn’t get the logic. Is it that when the project generates profit, the amount invested is reaped back?

Thanks

John Moffat says

Have you not watched the free lectures on relevant cash flows for investment appraisal??

Working capital is needed to finance receivables, inventory etc.. It is needed for the duration of the project, but once the project finishes then the working capital is no longer needed and therefore the cash is recovered.

anonymous says

Ok. Thank you so much. 馃檪

aliimranacca007 says

sir after deducting cost from sale revenue and then take the inflation rate is this mathod ok as answer is same..

John Moffat says

Yes that is fine (I do actually say that during the lecture).

aliimranacca007 says

Thank You sir..

sir dividend are not tax allowable its meaning there is no tax saving on dividend

Interest are tax allowable its mean there is tax saving on interest .

Is this correct sir ?

John Moffat says

That is correct 馃檪

sonia says

but have little confussion why you less inventory or cash because its current asset

John Moffat says

Because receivables are the balance of the current assets!

sonia says

hello sir can you please send me mock test answer for better parctise of mock test of MCQ

John Moffat says

No – sorry.

If you read the page before the test, it makes it clear that the test is selected at random from a large bank of questions – every time you attempt the test you are likely therefore to get different questions.

You can review your answers at the end of the test and see what the correct answers were.

As the page said, if you want workings for any of the questions then you need to copy the question in the Ask the Tutor Forum and I will explain.

sonia says

inventory 1m

cash 0.5m current liabilities 2.5 m current ratio 2.4 m sale 50 m (req) whayt is the recevble collection period ? plz solve this and show me workings

katerina1986 says

Current assets = cash+inventory+receivables

Then receivables=current assets-inventory-cash

Current ratio=current assets/current liabilities

Then current assets=current ratio*current liabilities=2,4*2,5=6

Receivables=6-1-0,5=4,5 m

Receivables collect period=receivables/sales*365= 4,5/50*365=32,85 days

I guess I am right

John Moffat says

Sonia: Did you not read my previous message?

You must NOT post questions like this as comments on lectures – you must post them in the Ask the Tutor Forum.

katerina1986 says

Hi John,

First of all thank you for your awesome lectures!!!

I have a question about the additional investments in working capital.

Why do we deduct the working capital of the previous year in this example?

Thank you,

Katya

John Moffat says

It is because we just need the extra each year to maintain the working capital at 10% of the revenue.

katerina1986 says

But how can I understand that the examiner means that we need an extra working capital?

I will try to explain what I mean:

In example 4 chapter 8 of the course notes: “additional $200 of WC will be required at the start of the project”. Here we just add $200 at the the start and deduct it after 3 years. It’s clear for me.

But in question 1 June 2013 of the past exam: “In addition to the initial cost of the new machinery, initial investment in working capital of $500,000 will be required. Investment in working capital will be subject to the general rate of inflation, which is expected to be 4路7% per year.” Here we add $500,000 in time 0 and do not deduct it at the end of the project (Machinery was replaced). Moreover during the project we deduct the amount above the $500,000 due to inflation.

I am a little bit confused about it. Could you help me?

Thank you,

Katya

John Moffat says

Firstly, do not say we add working capital at the start and deduct it at the end.

We investing working capital at the start and we received it at the end.

When there is inflation, extra working capital is needed each year to increase the level to that required.

In the December exam, the working capital is to be 10% of the revenue for the year, at the start of the year.

So since the revenue in the first year is 1308.75, working capital is needed of 130.88 at the start of the first year – i.e. at time 0.

The revenue in the second year is 2817.26 and so working capital is needed of 281.73 at the start of the second year – i.e. at time 1. However, there is already working capital of 130.88 and so only the additional 150.86 is required.

With regard to the recover at the end of the life of the project, there have only ever been two questions where the examiner did not recover it. In one question, you were specifically told in the question not to recover it. The other question was June 2013. The reason it was not recovered was that the question said that after the four years it would be replaced. The examiner therefore assumed that since the product would continue to be produced, the working capital would still be needed and would therefore not be recovered.

However, he did accept that it was an unusual thing to assume and he said that full marks would be given if the working capital had been recovered (even though the final answer would be different).

In the exam therefore, always recover the working capital unless specifically told not to.

katerina1986 says

Ok, I get it. Thank you very much!!

kayongajeanbosco says

DEAR SIR,

CONSIDERING THE TIME AVAILABLE, IS IT ALL THE TIME TO SHOW THE WOKINGS IN INVESTMENT APPRAISAL QUESTIONS AND IN SECTION A WHERE CALCULATIONS ARE ASKED?

John Moffat says

For Section A questions, although you will need your own workings they will not be looked at.

For Section B questions, neat workings are essential because the marks are for each step, not for the final answer.

helensqq says

Dear sir,

In your lecture notes, chapter 7 investment appraisal, include DCF-NPV, DCF-IRR, ROCE-ARR and payback period. Chapter 10 investment appraisal under uncertainty, include sensitivity analysis, expected value, simulation and risk adjusted discount rat-CAMP. I’m bit confused, are there any connections between 2 chapters? All numbers in chapter 7 are estimated anyway, so they are not certain too. In exam, if I am asked to discuss and comment the investment appraisals, what things should I included? Thanks.

John Moffat says

You have asked this in the Ask the Tutor forum, and I have replied there.

Please do not ask the same question in different places.

sandala123 says

Hi John,

can it be right if you leave out the working capital figure since it is in and out?

thanks

Sandala

John Moffat says

Not at all!!!!

What about the time value of money?

It may be the same amount that comes back, but when we discount it to account for the interest it is not the same amount.

sandala123 says

thank you very much.

jing says

Hi John,

I am little bit confused while doing pass exam NPV questions, some of the model answer given show capital allowance, the tax saving as a negative figure in the calculation, but some are positive. I did notice they position the capital allowance figures differently in terms of its layout but other than this, any other reason why some are negative and some are positive? e.g. Jun 09 Q4 NPV question has the negative tax saving figures but here for this question has positive figure. Many thanks, Jing

John Moffat says

Are you sure you mean June 2009? Question 4 was not a NPV question.

There are two ways that you can deal with capital allowances (both giving the same answer) and it is maybe this that is causing the confusion.

Suppose that in one year, the profit before allowances is 100, the capital allowances are 20, and the tax rate is 30%. No delay in the payment of tax.

One way is to calculate the taxable profit (100 – 20 = 80). Then calculate the tax payable (30% x 80 = 24), then the net cash flow (80 – 24 + 20 = 76). The 20 has been added back because it was not a cash flow – it was just needed for the tax calculations.

The other (easier and more common) way is to calculate the tax on the profit before allowances (100 x 30% = 30). Calculate the tax saved on allowances (20 x 30% = 6). And then calculate the net cash flow 100 – 30 + 6 = 76)

If you are asking about a different problem, then check which exam you are referring to and let me know.

jing says

Hi John, yes my mistake it was Jun 2008 Q4 that I was referring to. I realise that in Jun 08 Q4, the capital allowance did not include tax 30% as it was calculated as straight line, 1000/4 years = 250 a year. But the capital allowance in Dec 13 Q1 NPV question had included the tax when calculating the saving on reducing balance at 25%. Am I right to think that because in Jun 08 question, it did not include tax, therefore, it needs to be deducted before calculating the tax, reducing the taxable profit resulting in tax saving. However, in Dec 13, the tax had already been included the capital allowance calculation, so we need to add it back otherwise it would have been double counting?

Because this was not

John Moffat says

It is what I explained before.

In June 2008 he subtracted the CA’s to get the taxable profit, then he calculated the tax, then he added back the CA’s because they are not a cash flow.

In December 2013 he calculate the tax ignoring the CA’s and then separately calculated the tax saving on the CA’s.

You can always do it either way – they will give the same answer – but the December 2013 way is the easiest and safest.

jing says

thanks John

ucheval says

Please I need some clarification, when a question says dat ‘figures are stated in first year terms’ what does it really imply?

John Moffat says

It is relevant when there is inflation.

If you are told the figures for the first year, then the flows at time 1 will not be inflated (but they will be for later years).

If you are told that the flows are at current prices, then the flows at time 1 will be inflated (and inflated for each future year also).

You should watch my free lecture on Investment Appraisal with inflation and tax to see exactly what I mean.

jing says

Hi John, for working capital, is it always start from year 0?

John Moffat says

It depends what the question says.

Usually it says that the working capital is required immediately – this is time 0.

jing says

I find it confusing on how to identify the correct year. Do you have any tips on this?

In the question it says “The level of working capital investment at the start of each year is expected to be 10% of the sales revenue in that year”. It seems to me it should be starting from year 1 because year 0 did not have any revenue?

John Moffat says

It is time 0 (not year 0), time 1 (not year 1) and so on.

They are points in time.

Suppose our year end is 31 December and we buy a machine on 1 January 2013.

Time 0 is 1/1/2013.

The first year is year to 31/12/2013. We always assume that operating flows occur at the ends of year, and so the first revenue etc. occurs at 31/12/2013.

That is virtually one year from now (and it only matters because we are going to discount for one years interest), so 31/12/2013 is time 1.

So…..when it talks about the working capital at the start of each year, the start of the first year is 1/1/2013 – i.e. time 0.

The start of the second year is 1/1/2014, which is one year from now – i.e. time 1.

And so on.

It will be worthwhile you watching my lecture on this.

jing says

Thanks John, I am watching your lectures on this now. If the question only says the initial investment in working capital of $XXX will be required, can I assume it will start from T1 since it did not say the working capital is required from the beginning of the year?

John Moffat says

If it says an initial investment is required, then it means at the start i.e. at time 0.

shawkath says

in many answers working capital has not been added in the last year. can i know y?

John Moffat says

In most exam questions, the working capital is recovered at the end of the project.

However it depends on the question – if production is continuing, then the working capital will still be needed and is therefor not recovered.

(This was the case in Decembers exam. The question said that the machine would be replaced after four years. Obviously therefore, production was continuing. (Although the examiner did say that even if you had recovered the working capital, then you would still have been given full marks. ))

Fang says

This is also my question

John Moffat says

And it has been answered. 馃檪

Fang says

Thanks so much

John Moffat says

Let me give a tiny example to help explain:

Suppose you were receiving 10,000 at current prices, receivable in one years time.

Inflation is 5% and the nominal (actual) cost of capital is 15.5%.

You could either take the nominal approach and say that the actual cash flow will be 10,000 x 1.05, and then discount this cash flow at the actual cost of capital by multiplying by 1/1.155.

Alternatively you could take the ‘real’ approach and discount the real cash flow of 10,000 by the real cost of capital of 10% ((1.155/1.05) – 1)

Both would give exactly the same present value.

However, this only works when the number of years inflation is the same as the number of years of discounting (in my little example, 1 years inflation and 1 years discounting).

The problem referred to in the answer is that although this applies to the sales revenue, it does not apply to the working capital flows – for them there is always 1 years more inflation than the number of years that we are discounting.

I hope that helps.

(PS You will never need to discount at 15.5% in the exam – you will always be able to use tables. I only used 15.5% here to ‘prove’ it works 馃檪 )

jing says

thank you John!

jing says

Hi there,

When explaining why there are a difference between the nominal term and real term, the answer for Q1 (b) says “the working capital cash flows are timed differently to the sales income on which they depend, and so their inflation effects

are timed differently to the related inflation effects in the discount rate.” What does this means?

Many thanks,

Jing