I’m working on a model to determine the NPV of a new venture. I did all the calculations, and I’m assuming no debt financing just cash financing to start the project. To get my NPV, do I have to subtract working capital from my EBIT after I add back depreciation? Would presenting the data as be silly? Or can I make a note that I did not incorporate working capital? Please advise
You subtract the change in working capital, not the actual working capital balance. Cash flow is cash flow.
Right, I meant to say change in working capital
That’s like saying do I have to subtract operating expenses to get to net income? It would look so much better if we could just ignore itt…
Working capital invested in the project (measured as a change in working capital) is money/assets that is not available for investment elsewhere, so it’s a very real cost. So yes, include it. Why wouldn’t you? If you don’t know how much working capital you need, then take a best guess and note in your charts that you are assuming that working capital required is X. If you didn’t invest working capital, you’d have to get those assets somewhere else, like new debt or equity. Those would be costs for you too. So there’s no reason not to include it. BTW, one of the chief reasons for candidates messing up CorpFin questions on CFA L1 and L2 is forgetting to include investments of working capital. Just remember that it is a cost, just like anything else. The main advantage of working capital is that you tend to get the working capital back once/if the project is over.
Keep in mind, your objective isn’t to make the project look good. It is to objectively assess whether the project is worthwhile, more often than not the answer will be no in my experience…
Strictly speaking working capital is not a cost but the relation between costs and net result. When you purchase a good or service on credit, you incur a cost (assuming its not capitalized) and increase accounts payable. After such an operation, just by looking at your P&L you would only be able to deduce that your cash has decreased, whereas the increase in AP tells you that cash is unchanged (from this one operation). Simply speaking, working capital is about collecting/not collecting cash from customers and paying your bills. You can only leave it out when your business does not require any inventory and all your sales and costs are on a cash basis. Even then I suppose there would be a reason to include it (e.g. for items taking place over a period of time).