Question

Silver Sun Industrial is considering a project that would last for 3 years and have a cost of capital of 14.36 percent. The relevant level of net working capital for the project is expected to be 24,000 dollars immediately (at year 0); 7,000 dollars in 1 year; 36,000 dollars in 2 years; and 0 dollars in 3 years. Relevant expected operating cash flows and cash flows from capital spending in years 0, 1, 2, and 3 are presented in the following table. What is the net present value of this project?

	Time 0	Year 1	Year 2	Year 3
Operating cash flows (in dollars)	0	67,000	65,000	64,000
Cash flows from capital spending (in dollars)	-92,000	0	0	17,000

Answer 1

Pls find below the Net Present Value of this project:

Years	Step-reference	0	1	2	3
Operating cash flows	(A) - given in question	$0	$67,000	$65,000	$64,000
Cash flows from capital spending	(B) - given in question	($92,000)	$0	$0	$17,000
Net working Capital	(C) - refer working note (1) below	($24,000)	$17,000	($29,000)	$36,000
Net Cash flows	(D) - (A)+(B)+(C)	($116,000)	$84,000	$36,000	$117,000
Discount factor at 14.36%	(E) - refer working note (2) below	1.000	0.874	0.765	0.669
Present Value of Cash flows	(F) = (D)*(E)	($116,000)	$73,452	$27,527	$78,228
Net Present Value	Sum of all present value of cash flows in step (F)	$63,207

NPV of the project = $63,207

Working Note 1. Net working capital

Net working capital is the amount available for a company to meet its short-term expenses. It is calculated as current assets - current liabilities.

If the net working capital is positive (current assets higher than current liabilities), this is an negative event for cash flow - assuming debtors (part of current asset) is higher , it shows that the company has collected less from its customers compared to its sales and hence a cash-outflow event. Similarly, if the net working capital is negative (current assets lower than current liabilities), this is an positive event for cash flow - assuming creditors (part of current liablities) is higher , it shows that the company has paid less to its suppliers compared to its purchases and hence a cash-inflow event.

In the given question,

Net working capital level for year 0 = $24,000 . Its a positive net working capital(current assets higher than current liabilities) and hence will be a cash-outflow in year 0.

Net working capital level for year 1 = $7,000. Though this is a positive net working capital, there is a reduction of $17,000 ($24,000-$7,000) during the year which means during the year, current liabilities have been higher than current assets. Hence, this $17,000 is a cash inflow in year 1.

Net working capital level for year 2 = $36,000. This is a positive net working capital and there is a increase of $29,000 ($36,000-$7,000) during the year which means during the year, current assets have been higher than current liabilities. Hence, this $29,000 is a cash-outflow in year 2.

Net working capital level for year 3 = $0. Thus, there is a reduction of $36,000 ($36,000-$0) during the year which means during the year, current liabilities have been higher than current assets. Hence, this $36,000 is a cash inflow in year 3.

Working Note 2. Discount factor at 14.36%

Year 1 = 1/(100%+14.36%)^1=0.874

Year 2 = 1/(100%+14.36%)^2=0.765

Year 3 = 1/(100%+14.36%)^3=0.669