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In the above mentioned question we are told this line:
“Chmura Co will require MP200 million for working capital immediately. It is not expected that any further injections of working capital will be required for the five years. When the project ceases at the end of the fifth year, the working capital will be released back to Chmura Co.”
Later on we are told ” The current rate of inflation in Mehgam is 8%, and in the country where Chmura Co is based, it is 2%. It can be assumed that these inflation rates will not change for the foreseeable future.”
So when working capital was released in year five, why was it that it was released at the current value of MP 200 million and not adjusted for five year’s inflation at 8% (general inflation rate). This doesn’t make sense please help me as the above treatment was seen in the examine’rs answer.
Thank you.
Although it is obviously an assumption (and he covers himself in the first of the assumptions he lists), I think on balance that he is correct.
Working capital is the amount needed to finance receivables, inventory etc.. Normally we would expect the requirement to increase each year, simply because we would expect receivables etc to increase with inflation. (Working capital doesn’t just inflate by itself.) However, the question specifically says that no further injection of working capital is needed which suggests that the are maintaining the requirement at 200M (presumably by having a compensating reduction in receivables etc.) and therefore it is only 200M that will be released at the end.
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