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For a capital budgeting analysis a company requires an increase of $40,000 of working capital in...

For a capital budgeting analysis a company requires an increase of $40,000 of working capital in Year 0. The analysis assumes the $40,000 of working capital is returned at the end of the project. If the net change in working capital is always zero, can working capital be ignored in the analysis? Explain.

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Answer #1

Even though the net change in the working capital is always zero, as the working capital in year 0 is refunded at the end of the project, the values are different.

The working capital that you invest today will be worth $40,000. The same working capital returned at the end of the project will be worth less because of the time value of money. When we calculate the present value of the working capital that we receive at the end of the project it would be lower than $40,000.

Hence, even though the net change in working capital is always zero, we cannot ignore working capital in the analysis of capital budgeting.

Do let me know in the comment section in case of any doubt.

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