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Hi,
I’m a bit confused on why the working capita is calculated in different ways below on the BPP revision question book.
On Q42, it states additional initial investment working capital of £250k will also be needed and is expected to increase in line with inflation.
Therefore the answers have increased this by the inflation rate of 4.5% every year and used the incremental figure each year and when totalling the working capital, it does not add up to 0 from year 0 to 4
On Q43 it states additional initial investment of £750k would be needed for working capital. Inflation rate is 3% therefore the answers have increased it by 3% and used the incremental figures in the answer.
However when adding up the working capital, it all adds up to 0 from year 0 to 4
On Q54 it states additional investment in working capital of £90k will be required at the start of the first year of investment. Therefore the answers have entered -90 on year 0 and +90 in year 5.
My question is:
Why doesn’t Q42 add up to 0 from year 0-4 and Q43 does add up to 0 from year 0 – 4?
On Q54 why have they entered -90 in year 0 and +90 in year 5 and not used the same method as Q42 and Q43
How are we supposed to know which way to calculate the working capital?Thanks
I am away from home until Sunday and do not have the BPP book with me.
However, at the end of a project we always assume that all of the working capital is recovered (which means they add up to 0, but that is an awful way of thinking about it) unless the question says not to.
In every past exam question except for two of them, the working capital is recovered in full at the end of the life. The two exceptions were one where the question specifically said to ignore recovery of working capital; and one other where the examiner did not recover it in his answer because it seemed from the question that production would continue (and therefore the working capital would still be needed). However the examiner realised this was rather strange and so made it clear that if the wording capital had been recovered then students would still get full marks.
Thats great thank you for the hep. The wording on some of the questions are not very clear which makes it confusing on which way to calculate the working capital.
You are welcome, and yes – the wording is often one of the biggest problems 🙁
So should there always be a year 0 for working capital calculations? Refer to QN.48 of BPP Kit. It states that working capital for product P will need to be 7% of sales revenue for that year? Why then is the working capital computed from sales of year 1, placed under year 0 in the NPV proforma?
There is no such thing as year 0 or year 1.
They are points in time.
Time 0 is now, time 1 is one year from now and so on.
So the first year starts now (time 0) and it finishes in one years time (time 1).
The second year starts in one years time (time 1) and it finishes in two years time (time 2).
And so on.We always assume (unless told otherwise) that operating flows (profit and loss items) occur at the ends of years. So, for example, the sales revenue in the first year will occur at the end of the first year (time 1).
However, when working capital is needed at the start of the year, then for the first year it is need at time 0, for the second year it is needed at time 1, and so on.
I do suggest that you watch the free lectures on investment appraisal – our lectures are a complete course for F9 and cover everything you need to pass the exam well.
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