Business Study Notes is a free platform, which discussed the educational material and exam notes for business students, especially students of MBA, BBA, and DBA may easily get ready for their through business study notes. We may also said that business study notes is all about business study and business notes. Below this post is also all about business study notes and this time we are discussing here Working Capital and Additional investment on it.

In many projects (especially in the case of expansion projects), it is necessary to increase the quantity of inventories and accounts receivable in order to achieve the planned sales growth. In this way, it would eventually be necessary to make one or several additional investments in working capital.

Suppose, for example, that the administrators of Electrical del Norte consider that they will have to make additional investments in net working capital of $ 20,000 at the end of the first year of operations of the project and another $ 10,000 at the end of the third year. This situation is reflected in Table 1-9. It should be clear However; these figures are still preliminary for the complete calculation of cash flows, since the terminal cash flow still needs to be considered.

Cash Flow Terminal

Once the economic life of the project has ended, it is possible, in some cases, to sell the fixed assets that were used to carry it out, as well as to recover the net investment in the working capital. To illustrate these concepts more clearly, consider the example of the Electrical del Norte expansion project.

Suppose that the engineers and administrators of Electrical del Norte consider that, at the end of the five years that the new project to produce microwave-based bread roasters is estimated to last, the fixed assets could be sold for $ 100,000. The amount of money received from the sale of the assets, known as salvage value, implies of course additional income for the company at the end of the last year of operations. However, this income must also be declared for tax purposes.

Depending on the depreciation system selected by the company, the asset will have different accounting values ​​in books and, therefore, the basis for calculating the taxes corresponding to this extraordinary income will be different. If the company selected depreciation in a straight line, the calculation of the salvage value net of taxes that the company would receive would be shown in Table 1- 10. In this case, the $ 100,000 received by the company from the sale of the assets you have to subtract $ 40,000 that you must pay taxes. This amount is calculated from the gain on the sale of the asset, which results from deducting the book value of the assets at their sale price. As the assets are fully depreciated at the end of the five years the project lasts, their book value is zero. On the other hand, if the company opted for the immediate deduction, the taxes payable for the sale of the machinery and the net salvage value for this concept would be shown in Table 1-11. Recall that in these circumstances half of the assets

they can be depreciated in a straight line, but the other half are subject to the immediate deduction (in the first year) of 75 percent of their value. This means that assets that depreciate in a straight line will have a value of $ 0 at the end of five years, but those that depreciate by immediate deduction have a value of 25 percent of their cost, since this percentage would not change from the second.  In other words, of the $ 900,000 that the assets cost, $ 450,000 would depreciate by $ 90,000 per year during the five years until having a value of $ 0 at the end of that period. The other $ 450,000 would depreciate $ 337,500 ($ 450,000 × 0.75) the first year and the other 25 percent ($ 112,500) would not depreciate anymore.

Another very important component of terminal cash flow it is the recovery of the investment in net working capital. This is a particular feature of this investment; all disbursements destined to the net working capital are recovered at the end of the project. Why does this happen? Consider a simple example of a company that starts its operations by manufacturing and selling a single pair of shoes. Suppose, to further simplify the example, that all that is required to make that pair of shoes is a supplier’s raw material.

The company buys the raw material at, let’s says $ 100, manufactures the pair of shoes and sells it to a customer at a price of $ 110. With that money the company has enough to buy raw material for $ 100 to manufacture and sell the next pair of shoes. That is, with the money from the sale, the company has $ 100 to allocate for the purchase of raw materials and an additional $ 10. By the time this project is completed, the company will charge the client $ 110 for the last pair of shoes manufactured and sold; however, I would not buy more raw materials anymore because the project came to an end! We could think that of those last $ 110 would correspond to $ 10 of profit plus another $ 100 that invested to make the first pair of shoes and that is now recovering.

Finally, the net cash flow that the company would have during each of the five years that the project lasts would be as shown in Table 1-12. These calculations include both the operating cash flows of each year and all applicable non-operating cash flows. All these data, together with the calculation of the initial investment of the project, would be the basis for your financial evaluation.