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Hey all I need some help in understanding the treatment of Working Capital in this question. Please find below the an extract of the first paragraph.
Warden Co plans to buy a new machine. The cost of the machine, payable immediately, is $800,000 and the
machine has an expected life of five years. Additional investment in working capital of $90,000 will be required at
the start of the first year of operation. At the end of five years, the machine will be sold for scrap, with the scrap value
expected to be 5% of the initial purchase cost of the machine. The machine will not be replaced.I NOTICE THE MODEL ANSWER ADD THE WC IN YR 5, WHEN THE QUESTION STATES WC IS NEEDED IN YR 1. THIS IS CONFUSING ME, PLEASE HELP!!
THANKS
Hi,
The working capital is shown as a negative cash flow in year 0 ( zero) and will be shown as a positive cash flow in year 5. That’s how it should be. If you look at the model answer, have a look at the section below the 1-6 year workings.
It shows
Present value of cash inflows 993
Working capital investment (90)
Cost of Machine (800)This is where the W.capital has been shown as a outflow in the initial years.
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treating working capital (wc) as a kind of buffer, it would NOT be used up and disappear, so it needed to be added back at final year 5.
example: Account receivable (AR) is example of wc, during the years of operation, AR hold up and you need cash buffer for that. But at the end, it will be released when all clients paid u and no outstanding left.
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