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Math Help - Changes in working capital for cash flow

  1. #1
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    Changes in working capital for cash flow

    So I have this problem and don't understand why the solution is as stated below.

    A four-year investment project calls for an investment in working capital equal to 20% of next periodís sales. Estimated sales for the project in year one through four is: 200, 150, 120, 180, respectively.
    What is the net present value of the working capital investment if the discount rate is 10%?
    The cash flow is as follows

    Code:
    Period:                0         1         2        3         4
    Sales:                 0        200      150      120        180
    WC                    40        30        24       36          0
    change in WC:         -40       10        6        -12         36
    PV = -40 + \frac{10}{1.10}  + \frac{6}{1.10^2} - \frac{12}{1.10^3} + \frac{36}{1.10^4} \approx -10.38

    Why do I need to calculate the "change in working capital" (last line in the cash flow) to get the correct answer?

    The way I read the problem, I thought I only had to calculate the present value of the working capital (ie: 2nd line).
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  2. #2
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    Your present value calculation should include the revenues and the costs of the investment project.

    You are told that the costs are 20% of the next period sales, it is called "change in working capital" in your table, but it could equivalently say "cost" or "required investment".
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  3. #3
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    [now(10%)]?...[1]40...[2]30...[3]24...[4]36
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  4. #4
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    Quote Originally Posted by SpringFan25 View Post
    Your present value calculation should include the revenues and the costs of the investment project.

    You are told that the costs are 20% of the next period sales, it is called "change in working capital" in your table, but it could equivalently say "cost" or "required investment".
    Oh, thank you. English is not my native tongue, so a lot of these financial terms are all new to me.

    I think I understand it now. Working capital is resources for the daily operations, like inventory/raw materials or cash to pay daily costs?

    So since we need to invest 20 % of next years budgeted sales in working capital we essentially need to invest 40 initially. We can take out 10 in after one year, 6 after two, but then we need to invest another 12 in the third and we have a surplus of 36 in the last. Which we can take out and fund other projects, pay out dividends or what ever we find most profitable?
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  5. #5
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    yep
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