Company A is considering a new service. A THB 800,000 equipment budget is not the whole funding requirement: the project also needs THB 200,000 in working capital. This episode separates cash changes caused by accepting the project from amounts that would exist anyway, before a valuation formula is allowed to decide anything.
This is a hypothetical extension of the learning case, not the single-period statement in Episode 2. Time-zero investment is THB 1,000,000. All subsequent amounts are nominal baht, after tax, received at year-end, and measured before payments to financing providers. The assumptions are a project forecast, not observed company performance.
Assume after-tax operating cash before capital expenditure and changes in working capital is THB 450,000 annually for three years. THB 200,000 of working capital is released at the end of year three. There is no asset-sale receipt or continuing operation after the project. Tax effects are assumed included in the supplied cash forecast; VAT and withholding-tax timing are outside this exercise.
Ask what changes if the project is not undertaken
Incremental cash flow is the difference between undertaking the project and not undertaking it, not the company’s entire revenue stream. Reassigning existing employees may sacrifice other work or require replacement capacity. The absence of an immediate payroll increase does not establish that their time has no opportunity cost. Identify the consequence before assigning a number.
Money already spent and irrecoverable is a sunk cost. It does not justify proceeding merely to avoid admitting that a previous decision failed. Future cancellation fees, decommissioning costs, or income lost if the work stops are different: those are still consequences of a current choice. Draw the comparison around decisions that remain available.
If company-owned space could be rented out, using it for the project may forgo rental income. An opportunity cost needs a defensible alternative, not an arbitrary charge added to make the spreadsheet look conservative. Distinguish actual incremental payments from benefits sacrificed, while recognizing that both can matter to the economic comparison.
Put the payments and receipts on one timeline
At time zero, equipment of THB 800,000 and working capital of THB 200,000 produce a THB 1,000,000 outflow. Years one and two each contribute THB 450,000. Year three contributes THB 450,000 plus the THB 200,000 working-capital release, or THB 650,000. The complete vector is therefore −1,000,000; 450,000; 450,000; 650,000.
Working capital is not automatically a permanent expense. Here it is funded initially and recovered in full when the project closes. If receivables become uncollectible or inventory cannot be sold, the recovery must be revised. The terminal amount is an assumption requiring evidence, not an automatic accounting release that guarantees bank cash.
The THB 450,000 is neither revenue nor net profit. It is a supplied after-tax operating cash forecast for the exercise. A real proposal must show its drivers: customers, prices, collection, delivery costs, and taxes. An unexplained cash number is a useful classroom input but an inadequate investment submission, even when the resulting NPV looks attractive.
- Capital expenditure800
- Working capital200
- Operating cash450
- Working capital recovered200
Avoid counting capital expenditure, depreciation, and debt twice
When starting from after-tax operating profit, noncash depreciation may need to be added back before capital expenditure and an increase in operating working capital are deducted. Starting from the supplied THB 450,000 operating cash figure is different. Depreciation is already handled in that cash forecast, so adding it again would manufacture a benefit that is not present.
A common free cash flow to the firm (FCFF) construction is after-tax operating profit plus relevant noncash charges, less capital expenditure and the increase in noncash operating working capital. Definitions and signs matter. An increase in working capital consumes cash; a release provides cash. If operating cash already incorporates that movement, do not subtract it a second time.
Borrowing and principal repayment describe how the project is financed, not operating cash created by selling the service. If FCFF is discounted at a rate reflecting both debt and equity providers, deducting financing interest within those same flows can double count financing costs. The equity investor’s cash flow is a different measure, developed later in the series.
Transfer the reasoning to manufacturing, not the assumptions
For machinery, examine transport, installation, production downtime, materials, spares, and any disposal of old equipment. Include effects on existing products or production lines. Do not borrow the service project’s THB 450,000 forecast and label it a factory result. The transferable part is the comparison between alternatives, not the amount or operating pattern.
Exercise: if none of the THB 200,000 working capital is recovered, what is year-three cash? It becomes THB 450,000. Do not rewrite the initial investment as though it never occurred. Change the terminal outcome and recalculate value. This separates an actual cash commitment from the uncertain benefit expected when the project ends.
CFA Institute’s free-cash-flow reading distinguishes cash available to the firm from cash available to equity. Next we construct a rate compatible with our project cash. Only then can the THB 1,000,000 paid today be compared coherently with the future receipts, rather than with a mixture of accounting and financing numbers.