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In a capital investment we treat the investment in incremental working capital as a part of...

In a capital investment we treat the investment in incremental working capital as a part of the initial investment and recover exactly the same amount in the terminal value calculations. Since the amounts are the same and offset, why do we do that and how does that treatment affect the investment evaluation?

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Answer #1

The working capital is locked in the project till the end of its life due to which one does not earn return on the working capital. So, we are in effect getting lesser value as a dollar today is worth more than a dollar received in future because of time value of money. The net is -Investment now+Investment received in future/(1+rate)^t

Hence we cannot offset the two.

The investment becomes less attractive compared to a similar investment without working capital needs.

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