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Question: Working capital cash flow question?

(Posted by: Cody H on 2009-10-07 00:06:11)

ITT is building a new plant to make telephones in South Carolina. The initial working capital needs of the plant to finance inventory, payroll and so forth are $5M. Each year these needs are expected to increase by 5 percent. After five years the plant will be closed and the working capital recovered. In undertaking a capital budgeting exercise to see whether or not to build the plant, what are the cash flows that should be included to take account of the working capital

Posted by: rehman vohra on 2009-10-07, 21:47:07

For working capital needs, the cash flows will be recorded as $5m in year 0. In the subsequent years, additional amount of 5% on the opening balance will be recorded. For instance in year 1 $0.25m, year 2 $0.2625m, and so on until the life of the project. At the end of the project life of five years, the total investment will be recovered. Of course you will discount these entries at appropriate rate.