A divisional manager submitted a project proposal to the chief financial officer

Question

A divisional manager submitted a project proposal to the chief financial officer, complete with a calculated NPV for the project. The chief financial officer studied the proposal and pointed out that the divisional manager had failed to account for a one-time increase in net working capital of $60,000 that will be required over the life of the seven-year project. Assuming the full value of net working capital will be recovered at the end of the project, how will the project’s NPV change after making the chief financial officer’s adjustment? Assume a discount rate of 9%.

The NPV will not be affected.

The NPV will decrease by $32,822.

None of the above.

The NPV will decrease by $16,411.

The NPV will decrease by $60,000.

Explanation / Answer

The answer the the Question is "None of the above"

Effiect of Increase in Working Capital must be considered while calculating the NPV of the project and it will surely decrease the NPV of the project.

Additional working capital requirements at the beginning of the Project period will be considered as the Cash Outflows at 0 period and recovery of working capital after the project period of 7 years will be considered as Cash inflows and shall be discounted @ 9%

So

P.V of cash Outflow = $60,000 x 1 = $60,000

P.V of cash Inflow = $60,000 x 0.547= $32,820 (Considering the discounting factor @9% at the end of 7th year)

Net effect on NPV would be = $32,820-$60,000

= $27,180

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