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Dear Sir,
In question 1 there is the following information:“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 4·7% per year.”
Why is it calculated as incremental working capital and only that part is taken into account in calculation of NPV of investment, and not the whole working capital investment of $500 000 at the beginning, year 0, and then at year 4 it is taken back as positive cash flow of $500 000?
Thank you in advance for prompt response.
The whole 500,000 has been taken as an outflow at time 0 (it is shown in the calculation of the NPV of 4,162).
Because of the inflation, extra working capital is needed each year.
It has not been recovered at time 4 because the question says that the machine will be replaced (and therefore they will continue to produce the product and presumably the working capital will still be needed).
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