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Hi John
I dont understand how this example question of Kalpan answer works – please can you help?
Q: A company is considering a new project that will require an initial investment of $60,000 and will generate contributions as Year 1 $20,000, Year 2 $15,000, Year 3 $25,000 and Year 4 $40,000.
Working capital equal to 20% of the contribution needs to be in place at the start of each year. At a cost of capital of 10%, what is the NPV of the project to the nearest $50?
A:
t0 t1 t2 t3 t4
Investment (60,000)
Contribution 20,000 15,000 25,000 40,000
Working capital (4,000) 1,000 (2,000) (3,000) 8,000
Net cashflow (64,000) 21,000 13,000 22,000 48,000
Discount factor 1.000 0.909 0.826 0.751 0.683
Present Value (64,000) 19,089 10,738 16,522 32,784Net present value $15,133
I dont understand how the working capital of 20% of contribution is +1K in T1 then -2K and -3K in T2 and T3? But back to normal 20% of 40K (8K) in T4?
Thanks!
The working capital at time 0 is 205 x 20,000 = 4,000
At time 1 they need working capital to be 20% x 15,000 = 3,000. However they already have 4,000 and so they will get back as an inflow 1,000 so that they now have 3.000.
At time 2 they need working capital to be 20% x 25,000 = 5,000. However they already have 3,000 and so the need an extra outflow of 2,000.
It follows on in the same way until the end, when they recover all the remaining working capital as normal.
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