A company is considering a project that needs £20,000 additional working capital at the start, which will be recovered at the end of year 3. How is this treated in the NPV calculation?
Answer and explanation
Correct answer: D. £20,000 outflow at time 0 and £20,000 inflow in year 3
- Step 1: Money tied up in inventories and receivables is a cash outflow at the start of the project.
- Step 2: It is released at the end, creating an inflow at year 3.
- Step 3: Both flows are discounted.
Answer
£20,000 outflow at time 0 and £20,000 inflow in year 3.
Why not the others: £20,000 outflow at time 0 only: The working capital is recovered at the end, so there is a matching inflow. £20,000 inflow in year 3 only: The initial investment is also a cash flow and must be included. Working capital flows are cash flows and are included in appraisal.
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