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Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA AFM Exams › FCF – Incremental of Working Capital
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) = 3.606M
Instead 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 .
The working capital is the cash needed to finance the level of inventory etc needed.
The outflow at time 0 is $3M, so the level of working capital at that time is $3M.
At time 1 they need the working capital to be $3.24M. But they already have working capital of $3M, so it is only the extra $0.24 that is needed.
I do explain this in my free lectures on investment appraisal.