At this stage, we know that when estimating the FCFs of an investment project w

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At
this stage, we know that when estimating the FCFs of an investment
project we need to estimate EBIT*(1-t) or EBIAT, add back Depreciation
and any other Non-Cash Expenses, and then we have to subtract
Investments required by the project, and all of them for each period
being forecast. When considering required Investments, we have to
consider:
Investments in Fixed Assets, also called Capital Expenditures or CAPEX, and
Investments
in Working Capital (WC), also called Investments in Net Working Capital
(NWC) or Investments in Working Capital Requirements (WCR). Sometimes
people refer to them replacing the word “Investments” with the word
“Changes” in all the previous names. The reason is that the amount
invested in WC (or NWC or WCR) coincides with the change in WC (or NWC
or WCR) between this period (that we are estimating the FCFs for) and
the previous one. Sometimes people refer to this kind of investments as
Operating Expenditures or OPEX, which may be confusing, since even more
often people abbreviate Operating Expenses (a completely different
magnitude) as OPEX too. People use WC, NWC and WCR as different names
for the same magnitude. However, this a problem because Investments in
WC is the term chosen more frequently by more people. However, in this
context WC does not have the same meaning that accountants usually give
it, which is as (All) Current Assets minus (All) Current Liabilities.
Actually in this context, WC is (Some) Current Assets minus (Some)
Currrent Liabilities. And in fact, the name which better describes its
interpretation is Working Capital Requirements (WCR), which allows us to
understand that it is a different magnitude than WC, but paradoxically
WCR happens to be the least used name.
With these preamble, we want to focus here in understanding this magnitude of “Investments in WC(R)” in several steps:
We
said that WCR = (Some but not necessarily all) Current Assets – (Some
but not necessarily all) Current Liabilities. Let’s begin by trying to
explain and illustrate in the clearest way possible, which Current
Assets should be included and why.
It
should be almost as obvious as it is for Fixed Assets that the Current
Assets described in a) represent an investment. Can you explain why?
Can
you explain which Current Liabilities should be included in the
determination of WC(R) and why? Can you explain why the remaining
Current Liabilities are excluded?
The
answer to the coming question may have been implicitly or explicitly
provided in the answer to c) but, just in case, can you explain why if
Current Assets represent an investment as indicated in b), do we need to
worry at all about (some) current liabilities as described in c)?

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