2013 CFA Mock AM Q49 & Q50
Q49
Apart from the sloppy page layout and the misaligned table, as the gentlemen in previous post http://www.analystforum.com/forums/cfa-forums/cfa-level-ii-forum/91320915 point out, is interim WC Inv included in the after-tax operating CF when capital budgeting?
Q50
Why isnt the additional working capital for that year, .62, added to the capital required when figuring Capital * WACC? In bahgill’s words.
Q49:
You WILL include working capital investment in the total yearly cash flow, since it is a required cash outflow for the project and will affect capital budgeting decisions.
However, the question specifically asks for OPERATING cash flow. Hence you didn’t have to include working capital.
But as stated before, when computing NPV for the entire project you want to include all operating and required investing cash flows.
Q50:
$WACC = Beginning Capital * WACC. So capital added during the year doesn’t count until computing the following year’s $WACC.
Q49:
How about comment made by CarloRoco “OPERATING cash flows. an investment in WC is still part operating cashflows. and is included in the discounting process.”
Q50:
But normally do we assume capital investment is made at the begining, in the middle, at the end or evenly thought the year?
The vignette says:
The capital investment will be made at the end of 2012 (only)
They didn’t specifically say for the rest of the life of the project, assume all capital investmnet is made at year end… It’s ambiguous and assumptious at best, isn’t it?
Q49.
Let me dissect the comment really quick:
Working Capital is an operating cash flow, when you are taking th perspective of the cash flow statement. Since this is a capital budgeting, I believe they mean solely from operations in this question. After looking at how the answer was calulated for question 49, they in fact did leave out working capital and included an operations perspective only (that differs from how you would do it on the cash flow statement).
Even though working capital cash flow isn’t included in what the problem considers “operating cash flow”, it is still included in the discounting process as Carlo said. So you use the combined cash flows of operating & working capital & investments when finding the overall NPV of the project.
Let me know what you think!
Q50:
Yes, I see what you are saying. Most times in accounting though, when you are creating costs like $WACC you usually use the beginning amount or average . The capital investment didn’t have to be made at year end (it could have been made throughout the year). Although, this process of figuring out the exact time when it was made during the year, and adjusting its relevant affect on $WACC can be very tedious. Therefore, it is easier to just use the beginning amount to make the process more efficient.
^BTW i’m not saying this is the exact reason why they use beginning amounts, but it seems like a logical conclusion that works.
Q49.
Ok got it. Definition problem, OPERATING means differerent things in capital budgeting and just follow the formula will do. Thanks al lot.
Q50.
But the thing is the provided answer assumes addtional WC Inv is made at year end of 2013 so they don’t include it in $WACC…
The provided answer uses beginning Total Capital for 2013, and beginning total capital for 2013 equals ending total capital for 2012. Therefore, whether the 2013 working capital expenditures were made on January 2nd or in the middle of the year or at the end of the year doesn’t matter as it wouldn’t be included in the beginning amount in any case.
Let me know if that helps or not!
What if you made the 2013 working capital expenditures on 1st January? Then 2013 working capital expenditures would be added to the beginning total capital of 2013 right?
Since you put the 2013 working capital in use and earn a profit on it in year 2013, why don’t you account the required cost of capital from this 2013 WC Inv in deriving Economic Profit for the year 2013?
In response to the first paragraph:
Sorry I should have included January 1st. If you purchase it on January 1st, 2013 then it was a purchase made during 2013 and doesn’t affect the 2012 ending number. So the 2012 ending number is still correct. Let me make a quick comparison that doesn’t relate to working capital but should send home the basic point:
On December 31, 2012, the stock market closed at a level of 1000. Lets say on January 1st, 2013 the market goes 1000 points to 2000, a 100% gain. Would you either say A) Because of its gains on January 1st, 2013, we actually believe the 2013 beginning value of the stock market is 2000; OR B) The market began 2013 at a level of 1000, but made a miraculous climb to 2000 on January 1st, therefore the market is up 100% for the year.
B would obviously be the correct way to interpret what happened on January 1st :), thats why you don’t include purchases for working capital into the beginning amount for 2013 as the purchase were made during the year.
In response to the second paragraph:
As for your second comment. In the real world, if you had those detailed facts about when you purchased working capital, you could totally make the professional judgement call and include it. However you would have to adjust the cost to reflect the portion of the year it was active. IE if it was purchased during the last quarter of the year then the additional $WACC cost for that piece of working capital purchased during the last quarter would be: Working Capital * WACC/4. But since we don’t have the exact times at which we bought the working capital we can’t accurately compute the cost. Therefore the book just considers using the end of period 2012 number (the beginning 2013) number as the most efficient way to compute $WACC for 2013.
Hopefully thats provides some clarity
OK, I think I’m starting to see it from your POV but at same time I feel my head is gonna explode anytime.
I like your conclusion “using previous year ending capital is the most efficient way to compute $WACC”, save a lot of time and get rid of ambiguity.
Thanks for your efforts, time and explanations!!!
Np, man! Ya in the end its just more assumptions being made by the CFA
Best of luck on Saturday!
Thanks, you too! Let’s just pass this stupid test 