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Sir,
My question is an MCQ, question number 107 of BPP revision kit.A project has the projected cash inflows
Yr 1-100,00
Yr 2-125,000
Yr 3-105,000
Working capital is required to be in place of the start of each year equal to 10% of cash inflows for that year. The cost of capital is 10%. What is the PV of the working capital.Sir can u kindly explain how he has arrived at the solution? I am mainly confused of incremental cash flows and why he has done it? Also the Working capital is 0 at T4.Why is it so? Shouldnt we be assuming that the total working capital will be released at the end i.e T4? Plz help me with this question.
In the exam when do we use incremental working capital and when not to use it?Thanking you sir for your constant help and guide.
Please don’t copy out questions in full because of copyright issues. I have the current edition of the BPP Revision Kit and so just giving the number of the question is enough 🙂
The start of the first year is time 0, and so at time 0 they need working capital of 10% x 100,000 = $10,000 (outflow).
At time 1 (the start of the second year) they need the working capital to be 10% x 125,000 = $12,500. However they already have $10,000, so they need an extra $2,500 (outflow).
At time 2 (the start of the third year) they need the working capital to be 10% x 105,000 = $10,500. However they already have 12,500 so they take back $2,000 (inflow).
Time 3 is the end of the third year and the end of the project and so the working capital all released. As at time 2 they had 10,500 so at time 3 they get back $10,500 (inflow).
We always use incremental working capital – how it applies depends on the wording of the question. Sometime it is just required at the start of the project, other times (like here) we need to keep adjusting the amount each year.
Thank you so much sir for your constant help and guide,we all are very blessed to have a teacher like you.
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