18 changes in net working capital nwc nwc current

18
Changes in Net Working Capital (NWC)
°
NWC = current assets – current liabilities
°
A new project typically requires an investment in NWC
±
Extra cash (e.g. to provide change to customers)
±
Inventories (e.g. spare parts)
°
These investments are often recovered at the end of the project
°
Decision:
±
include initial NWC investment, changes in NWC, recovery of NWC
±
investment in NWC and its recovery do not affect taxes
°
Example: You provide $200 in NWC at the beginning of a project and
recover $200 at the end of the project.

10
19
Depreciation
°
Straight-line
±
D = (asset price + installation – salvage value) / useful life
°
MACRS (Modified Accelerated Cost Recovery System)
±
D = (% value in the table) * (asset price + installation)
±
MACRS depreciates all assets to the book value of zero
°
Depreciation is a non-cash expense but it affects cash flows by
reducing taxes
±
Tax Shield = (depreciation expense)*(tax rate)
20
Capital Investment (CapEx)
°
An asset purchase reflects capital expenditures (CapEx) and
represents a cash outflow
°
An asset sale has the following effects:
±
1. Record the sale price as an inflow (i.e. as negative CapEx)
±
2. Record the tax effect from the sale:
±
Tax effect = tax rate * (sale price – book value)
±
If the asset is sold at a gain ´ subtract taxes on gain
±
If the asset is sold at a loss ´ add tax savings from loss

11
Revenues
– costs
– depreciation
= Taxable income from operations
– taxes
= Net operating income
+ depreciation
– capital expenditures
– taxes from gain on asset sale (or + tax savings from loss)
– increases in working capital (or + decreases in working capital )
+ after-tax synergy effects (or – after-tax cannibalization effects ), if any
– opportunity costs today, + opportunity costs after project ends
= Free Cash Flow
21
Free Cash Flow for a Project - Recipe
22
Example 1: Comprehensive Cash Flow Problem
°
We are evaluating an investment project in the production of
shampoo at a consumer products factory that we currently manage.
The project requires purchasing new equipment for $3,400,000 and
preparing it for operation, which costs another $60,000. The
equipment will be depreciated based on the 5-year MACRS schedule
and is expected to be sold for $200,000 at the end of project’s life
(end of year 6). In addition to the fixed assets, the project requires
an immediate investment in working capital in the amount of
$200,000, which will be recovered at the end of year 6.
°
Our company regularly incurs annual overhead expenses of $1
million for legal counsel and administration. These expenses are
allocated to products based on products’ share in total sales, and this
share for the new shampoo is 10%.