Question

1. 3-year project. Immediately set aside $200 cash, increase it by 50% each year. Year 0-1-2-3 "change in NWC" timeline is:

Answer: -200, -100, -150, 450 <- check solution

• Year 0: NWC = $200
  • ∆ in NWC = -200
• Year 1: NWC = $200 * 1.5 = $300
  • ∆ in NWC = $300 – $200 = $100 Negative = - $100
• Year 2: NWC = $300 * 1.5 = $450
  • ∆ in NWC = $450 – $300 = $150 Negative = - $150
• Year 3: NWC = $450 * 1.5 = $675
  • ∆ in NWC = $675 – $450 = $225 Negative = - $225
  • Recover by Year 3 = $675

I cannot figure out how to get the $450 by Year 3. Please help! How do you get to this solution? $450

Answer 1

Project life is 3 years.

When a new project is started some amount is required towards Working Capital.

This amount is not a capital investment in project but additional amount required to fund cash cycle, that is, to invest in stock, advance payments to supplier and for selling on credit to Debtors.

When Working Capital is invested in project it is recovered at the end of project.

Investment start of project (year 0) = -200

Investment at end of year 1 = -100

Investment at end of year 2 = -150

At the end of year 3 (that is end of project), entire amount invested towards working capital will be receovered.

So amount recovered will be = +450

If we think it your way,

Investment at the end of year 3 = -225

Recovery at the end of year 3 = +675

Net amount recovered at the end of year 3 = +450 {+675-225}

However, it is bit incorrect to think this way.

Thumbs up please if satisfied. :)

Comment if further doubts in above solution.