capital budgeting question-not related to cfa

[meeee20]

Note: The institute that conducts my exams assumes that working capital is being recovered at the end of the project.
q.1)if at the beginning of the project $20 are being invested in inventory should i assume that these $20 as an inflow at the end of the project as sale of these inventoy would automatically show up in the sales of the last year of project?
q.2)if working capital is invested in cash,should it be taken as an outflow? i remember while calculating FCFE in L2 that working capital invested in cash should be avoided as what we are looking to generate is cash..shouldnt the same follow in capital budgeting too?
thanks

 

[suspense]

1. Yes

 

[S2000magician]

2, Yes.
If you borrow some money at the start of the project, you have to pay it back at the end.

 

[dirkan]

Focus on other things. Don’t waste time. CFA I is just around thecorner

 

[sooraj]

Dirkan - you are in the L3 thread. So meee20 is not going to care about CFA 1, he has passed 2 levels already.

 

[meeee20]

can someone explain to me the second question please??s200magician???

 

[S2000magician]

A working capital investment in cash would mean – as far as I can tell – that you borrow money. Perhaps you need cash to finance short-term perchases. Or something.
In any case, eventually, you have to pay that cash back. You borrowed it.
Thus, you have a cash inflow (positive CFF) when you borrow the money, and a cash outflow (negative CFF) when you repay it.

 

[meeee20]

but the question never mentions that u borrowed to finance your working capital..it could be financed of internally generated funds too right? in that case what would be the treatment

 

[busprof]

The logic behind the treatment of WC at the beginning of the project is that it is an investment (and therefore an outflow). The traditional way to handle the terminal year of the project is that all resources are set back to pre-project levels. I liken it to the Boy Scout motto of “leave the campsite as you found it”.
In other words, you receive any cash flows from operating the project in the terminal year and then deal with all the “non-operating” cash flows. So, you reset working capital to pre-project levels, sell off the fixed asssets, pay the taxes on those sales, etc… Or said another way, you’re rolling up the carpet, and selling off your stuff.
So, since the investment in WC represented an outflow initially (since an increase in an asset account represents a USE of cash), resetting it back to pre-project levels will mean a DECREASE in inventory (and a decrease in an asset account represents a SOURCE of cash).