HARD QUESTION (expert level) difference, budgeting, investment, valuation, between

badonkus

Ok guys, no peeking at notes here. This took me a while to figure out. Maybe y'all experts know this, but I consider this expert level.


Q. Tell me the difference between calculating Net Working Capital investment in capital budgeting and calculating Working Capital investment in Free Cash Flow valuation modeling. (there IS a difference, albeit slight)

Houjichasan

for free cash flow valuation u do not consider cash and short-term debt when calculating working capital

economicz

Haha! Nice.

What is included in "short term debt"?

mengxu

Notes payable, the current interest payable on long term debt, etc.

defour44

Nailed it.


This is an easy one.

Calculate FCFE using debt ratios.

SFoyil

sorry, but this answer is not correct:

"for free cash flow valuation u do not consider cash and short-term debt when calculating working capital"

for FCF valuation you consider changes in acc. receivable, change in inventory and change in acc. payable.

so short term debt is inculded!

so the difference is only the cash component, isnt' it?

wizofoz

great handle

yalo

Change in AR + Change in Inv - Change in AP = the NWCInv.

If NWCInv is negative, then it is a INFLOW of cash.

eoin

yeah i know that formula.but the question was the difference between the calculation of nwc in FCF analysis and capital budgeting

troymo

Correct, yella, for capital budgeting it's simple: CA - CL.

Let me type in verbatim CFAI Volume IV page 385:
"Although working capital is often defined as current assets minus current liabilities, working capital for cash flow and valuation purposes is defined to exclude cash and short-term debt (which includes notes payable and the current portion of long-term debt). When finding the net increase in working capital for the purpose of calculating free cash flow, we define working capital to exclude cash and cash equivalents as well as notes payable and the current portion of long-term debt. Cash and cash equivalents are excluded because a change in cash is what we are trying to explain. Notes payable and the current portion of long-term debt are excluded because they are liabilities with explicit interest costs that make them financing items rather than operating items." (pg. 386 Reading 41: Free Cash Flow Valuation)

Hope this helps. I think it's rather important not to confuse the two fomulae.

Best in June!