Replacement project Purchase price $8k shipping and installation $2k sale price of old machine $6k Book val of old mach $2k inventory increase if new machine is insatlled $3k payables increase if new machine is installed 1k marginal tax rate 25% The answer is Initial cash flow is -7k. I just don’t get the last part of this calculation. So we have -8-2+6-(0.25)(6-2) = - $5k (which is all fine) THEN for some reason it’s -$5k - (3-1) = -$7K The thing I don’t get is why do you minus the final (3-1) surely you should add that as it’s more of assets are increasing than liability therefore an increase in net working capital? Any help appreciated. Thanks
This is at the start of the project. You need to invest 2K more for NWC. So that is a cash outflow, hence -ve sign. you would need to add that back at the end when the project is terminated. hope this explains.
Its clear why u need to invest in WC when you start a business. Its also clear that this is a cash outflow. Why do u take it back at the end tho.? Obviously the CFAI curriculum says so but whats the intuition behind that?
Because you don’t need to buy extra inventory for that piece of equipment when it is terminated in its use.
You added $3 of inventory, by spending $2 in cash and $1 in credit- hence your payables going up by $1. So your cash out was $2 for the NWC. -$5 for the machine purchase, sale, and tax; then -$2 for the NWC