Question

Let's suppose that the net working capital requirements for a project is the 20% of the projected annual sales for each year.

Let's suppose a project has a 4 years life period.

In cases we want to calculate the net working capital , we add only the changes in Net working capital for years 1-4.Why only the changes?

Why at time year=0 , we add the whole working capital requirements (20% X sales of next year)? Please try to explain it clearly?

Answer 1

The case can be explained with an example:	0	1	2	3	4
Let the sale for four years be		100	220	260	300
Working capital needed at the beginning of the year, say at
10% would be 10, 22, 26 and 30 for the four years.
As working capital for a year would be needed at the beginning
of the year, the following would be the outflow on account of
working capital.
The initial amount is needed at t0, which is 100*10% = 10.
This is the entire amount as the project is just taking off.
The working capital for the second year should be 220*10% = 22
As there is already 10 in place, the balance of 12 only is required.
Since this is required at the beginning of the 2nd year, it will be
shown under Year 1 (it is end of Year 21.
Remember that, in the table provided to the right, 1, 2, 3 and 4
represent the end of the years 1, 2, 3 and 4.
For EOY 2, it will be 260*10%-22 = 4, and for EOY 3, it will be
300*10%-26 = 4
So the ouutflow for working capital will be	10	12	4	4	-30
For EOY 4, the entire working capital accumulated of 300*10% =30
(which is built up as 10+12+4+4 = 30 over the years) will be realised.
It will be a cash inflow for EOY 4.