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Hi. I am attempting question 1 from December 2011 part a and there is something I need to understand: in the question we are told that a further investment of £90000 pounds is required at the beginning of year 1 and this is ok: however when looking at the answer those £90000 are added in year 5 to the after tax cash flow plus the scrap value of the machine? Could you explain this step to me? I only considered the extra £90000 when deducting this amount along with the the original investment of £800000 when working the npv of the entire project.
The 90,000 is for working capital (i.e. the cost of financing the extra inventories/receivables etc. that are needed).
We always assume that this is needed throughout the life of the project, but that at the end it is no longer needed and we get it back.
A working capital outflow always results in an inflow of the same amount at the end of the project (unless obviously you are told differently in the question).
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