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Hello, Sir!
Could you please help me with one question from Kaplan Exam Kit (#25,p.50).
According to the question: The level of working capital investment at the start of each year is expected ti be 10% of the sales revenue in that year.
As I understood from the lectures we assume working capital investment get back in the end of the project (if no other noted), so I had following cash flows (project for 4 years).
Sales revenue by times
1 – 1309
2 – 2817
3 – 7908
4 – 5444
Working capital investments (10% of sales revenue each year, as in the question):
1 – (131)
2 – (282)
3 – (791)
4 – (544)
5 – (get back work.cap. invst-s) – 1748.
I was wrong, according to the answers there were following workings on work.cap.:
1 – 131, Incremental (131)
2 – 282, Incremental (151)
3 – 791, Incremental (509)
4 – 246, Incremental 246
In the end CF in line “Working capital” were as following:
1 – (151)
2 – (509)
3 – 246
4 – 544I completely didn’t understand why they deal with it like this? Could you, please, explain what does it mean and was I wrong in my calculation?
Thank you in advance!
Maria.I want to know this too
I believe it maybe because they worded it as “Start of each year” – same wording as when they’re describing the initial investment which normally falls on Year 0. Therefore the -131 falls in Year 0.
The final 544 balances it to 0.
Need some clarifications however,
There are two separate issues here:
Firstly (especially in respect of Shiser’s question) there is no such thing as ‘year 0’
Time 0 is a point in time – the start of the first year.
Time 1 is one year later – the end of the first year and the start of the second year
Time 2 is another year later – the end of the second year and the start of the third year
and so on.So the first working capital requirement is 10% of the first years revenue – 10% x 1250 x 1.047 = 131.
This is needed at the start of the year – i.e. time 0 (and Kaplan have listed it separately, added in to the initial investment needed for the project)The second issue is as regards the future years.
The working capital required at the start of the second year (time 1) is 10% of the second years revenue, which is 10% x 2,570 x (1.047)^2 = 282.
However, they already have 131 of working capital, and so to bring it up to the level required needs an extra 282-131 = 151 at time 2.Similarly at time 3, the working capital needs to be increased to 791, but since there is already a total of 282, it is the extra that is needed – the extra is 509.
That hopefully makes sense of the rest of the figures. At time 4 the working capital needed is lower, and so there is a cash inflow of the difference, and finally at the end of the project we recover the total of all the working capital that has been invested.
Suppose the question says the working capital will be purchased at the END of year and any changes to WC will occur at the end of year 1. will the answer be different to the above question?
Sorry sir. it’s confusing me please help
Yes it would be different.
If working capital is needed at the start of the year, then the first outflow is at time 0 (time 0 is the start of the first year). If it is needed at the end of the year then the first outflow is at time 1 (time 1 is the end of the first year and start of the second year).
The first working capital is always needed at the start of the first year (time 0) because of the whole nature of what working capital is. Have you watched my free lectures on investment appraisal with working capital?
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