We will begin the study of the computation of cash flows for investments that have to do with the growth of a company, that is, expansion projects. Determination of Initial Investment
Of course, the initial investment must include the necessary disbursement to acquire , transport and install the machinery and equipment required to carry out the project and, where appropriate , also the disbursements to buy the land, buildings and other assets fixed that are required. In addition, the net investment in working capital should also be included here. For purposes of the capital budget valuation models, it is considered that the initial investment occurs in period zero, that is, at the moment in which the project will start. Of course, these disbursements actually occur not in a single moment, but over several weeks or months. For all practical purposes, however, the assumption that they occur in a single moment is valid, since the distortion that this assumption produces is minimal in most cases.
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The initial investment is the sum of all disbursements that occur in period zero minus the positive cash flows (if any) that occurred in that same period. Table 1 shows, by means of an example, the procedure for calculating the initial investment of an expansion project. Consider that Electrical del Norte, dedicated to the manufacture of electronic devices is interested in extending its operations through an expansion project. This project consists of introducing to the market a new bread toaster based on microwaves that would compete with the traditional toasters based on electric resistances. The machinery and equipment to manufacture the new product will cost $ 800,000 and another $ 100,000 will be required to install them. In addition, the net investment of working capital will be $ 50,000
To calculate the change in net working capital are still several steps. First, increases in current assets are added, subtracting all the decreases in said assets to determine the net change in current assets. Then all the increases in current liabilities are added and all the decreases are subtracted to calculate the net change in current liabilities. Finally, to establish the change in net working capital, the net change in current assets is subtracted from the change net in current liabilities.
Suppose that the financial manager of Electrical del Norte expects that the new project will increase accounts receivable by $ 35,000 and inventories by $ 40,000. The Cash and Negotiable Securities account will not undergo any change. It also expects accounts receivable from suppliers to increase by $ 35,000 and that, due to greater automation of the production process that will affect other areas of the company, the accumulated liabilities will decrease by $ 10,000. The net working capital increase of $ 50,000 required for the microwave roaster project is established as shown in. If you want to learn more about such business related matters, you need to visit Business Study Notes. Business Study Notes is all about free online notes, business education and business study online, especially the students of MBA, BBA, & DBA may easily get ready for their exams through Business Study Notes.