Question

Change in net working capital calculation   Samuels Manufacturing is considering the purchase of a new machine to replace one it believes is obsolete. The firm has total current assets of $915,000 and total current liabilities of $630,000. As a result of the proposed​ replacement, the following changes are anticipated in the levels of the current asset and current liability accounts noted.

Account	Change
Accruals	+$37,000
Marketable securities	0
Inventories	−19,000
Accounts payable	+87,000
Notes payable	0
Accounts receivable	+148,000
Cash	+19,000

a. Using the information​ given, calculate any change in networking capital that is expected to result from the proposed replacement action.

b. Explain why a change in these current accounts would be relevant in determining the initial investment for the proposed capital expenditure.

c. Would the change in networking capital enter into any of the other cash flow components that make up the relevant cash​ flows? Explain.

a. The change in net working capital is $___

Answer 1

	USD
Current Assets	915,000
Current Liabilities	630,000
Net working capital	285,000
a) Change in the networking capital (NWC) due to proposed replacement action
Accounts	Chane in USD
Increase in accruals	(37,000)	(Increase in accrual will result in decrease in NWC)
Decrease in inventories	(19,000)	(Decrease in inventories will result in decrease in NWC)
Increase in accounts payables	(87,000)	(Increase in inventories will result in decrease in NWC)
Increase in accounts receivables	148,000	(Increase in accounts receivable will result in increase in NWC)
Increase in cash	19,000	(Increase in cash will result in increase in NWC)
Change in net working capital	24,000
b) Change in current account is relevant in deterimining the initial investment because it impacts the cash flow of the company.
A higher net working capital due to the replacement indicates cash outflow, while the opposite is true for a lower net working capital
This will directly impact the NPV of the replacement decision
Thus, it is relevant to determine the impact in current account amounts to evaluate replacement of the machine. c) The change in net working capital also impacts "Cash flow from operating activities". Positive change in the net working capital results in lower operating cash flow and vice-versa. In other words, if the current assets increases or current liabilities decreases, it means that the cash of the company is stuck. While on the other hand, if the current asset decreases or current liabilities increases, it indicates that the cash is released due to operating actitivities. d) The net working capital will increase by $24,000 Before the replacement of the machine, the NWC is $285,000 Post the replacement, the net working capital will be $285,000 + $24,000 = $309,000