Corp Fin - Cap Budgeting, NWCinv

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oktavian

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My question is: after the exam, when calculating NPV can I just use cash in and out flows and forget this formula:
initial outlay = CFInv + NWCInv
If I’m understanding it correctly, using NWCInv is a simplification that allows us to aggregate revenues and costs in the year of sale, in the form of: CF = (S - C) * (1 - T) + TD
So NWCInv of the initial outlay is the cost associated with cash inflows in Year 1. And the C part of CF1 is the cost of items for sale in Year 2…?
Actually this ‘simplification’ messed up my intuitive understanding for quite a while.
In the real world will I be able to do this:
- record cash inflows (from customers) at the expected time of receival
- record cash outflows (to suppliers, lenders, tax authority) at the expected time of payment
- completely ignore changes in receivables, inventory, payables
I understand that using NWCInv makes the calculation less fiddly in an exam situation, but in the real world, surely almost no companies will assume constant WC…?
 
You’d be hard pressed projecting cash flows without a financial statement format.
Don’t forget that the NWC at the end of the lifetime is a cash inflow, and needs to estimated as well.
 
I’m quite happy with the treatment of NWCInv for the exam. My question is, after the exam (in the real world), if I account for exact CFs at the time of payment/receival (e.g. pay supplier, cash from customer) can I stop using NWCInv. I think the answer is ‘yes’ but want to check.
If WC is always constant, I will get the same answer as the exam formula; if WC varies over the life of the project (e.g. NWCInv at time 0 ≠ NWCInv at termination) then I will get a more accurate answer.
 
do you mean to say
$100 paid out today and receive $150 in 1 year
is the same as
$110 paid out today and receive $160 in 1 year
$10 is the constant cash flow (constant WC)
try it out and see please.
 
Hmm, I don’t know whether to explain further or to cut my losses…?
Ok so, calculating NPVs requires looking at after-tax, incremental CFs. Accounts receivable, for example, is by definition NOT a CF (and change in accounts receivable is also not a CF). I’m fairly vague on why you would add change in accounts receivable to the initial outlat but I assume it represents the first cash purchase of inventory and services which will not yield a cash in flow until the first sales; at which point, this cash inflow is offset by a outflow to buy materials for the next sales (which is the same size as the initial change in accounts receivable)…. and this repeats until finally there is no new outflow (added to terminal cash flow).
To me, this seems to make a lot of unnecesary assumptions, just to make the calculations shorter by a few minutes. In reality, I guess you can simply discount the CFs to suppliers, and CFs from customers at the expected times of occurance and do away with a constant NWCInv number altogther. This allows for predicting fluctuating inventory size, change in receivable turnover etc. and at the same time, is much more intuitive…. it’s just discounting actual CFs.
Well, after writing basically the same question 3 times, I’m pretty convinced this method is not a problem. (depending on MrSmart’s reply…?)
 
Think of working capital investment as buying initial inventory: you have to spend a bunch of cash to be prepared for the onslaught of customers.
After the fad fades, you sell the remaining inventory without replacing it.
 
oktavian wrote:
Hmm, I don’t know whether to explain further or to cut my losses…?
Ok so, calculating NPVs requires looking at after-tax, incremental CFs. Accounts receivable, for example, is by definition NOT a CF (and change in accounts receivable is also not a CF). I’m fairly vague on why you would add change in accounts receivable to the initial outlat but I assume it represents the first cash purchase of inventory and services which will not yield a cash in flow until the first sales; at which point, this cash inflow is offset by a outflow to buy materials for the next sales (which is the same size as the initial change in accounts receivable)…. and this repeats until finally there is no new outflow (added to terminal cash flow).
To me, this seems to make a lot of unnecesary assumptions, just to make the calculations shorter by a few minutes. In reality, I guess you can simply discount the CFs to suppliers, and CFs from customers at the expected times of occurance and do away with a constant NWCInv number altogther. This allows for predicting fluctuating inventory size, change in receivable turnover etc. and at the same time, is much more intuitive…. it’s just discounting actual CFs.
Well, after writing basically the same question 3 times, I’m pretty convinced this method is not a problem. (depending on MrSmart’s reply…?)
Click to expand...
Stopped reading there.
On a side note, if you’re going to only use a cash flow statement format to derive NPV, then how would you optimize margins, keep track of working capital or project tax expense?
 
MrSmart wrote:
Stopped reading there.
Click to expand...
… any reason why..?
MrSmart wrote:
On a side note, if you’re going to only use a cash flow statement format to derive NPV, then how would you optimize margins, keep track of working capital or project tax expense?
Click to expand...
I’m saying predict the size and timing of CFs… of course use the income statement to predict tax expense.
I still don’t know where the problem in communication is here. Let’s just leave the topic…
 
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