Q. Evaluation of Net working capital?
The evaluation presumes that several key variables will remain constant such as the inflation rates, discount rate and the taxation rate. In reality this is improbable. The taxation rate is the matter of government policy as well as so may change due to political or economic necessity. Particular inflation rates are difficult to predict for more than a short distance into the future and in practice are found to be constantly changing. The range of inflation rates utilize in the evaluation is questionable since over time one would expect the rates to converge. Given the improbability of future inflation rates using a single average inflation rate might well be preferable to using specific inflation rates. The discount rate is probable to change as the company's capital structure changes.
For instance issuing debentures with an interest rate of 9% is probable to decrease the average cost of capital. Glance at the incremental fixed production costs it seems odd that nominal fixed production costs continue to increase even when sales are falling. It as well seems odd that incremental fixed production costs remain constant in real terms when production volumes are changing. It is likely that some of these fixed production costs are stepped, in which case they must decrease.
The predicts of sales volume seem to be too precise predicting as they do the growth maturity and decline phases of the product life-cycle. In practice it is probable that improvements or redesign could extend the life of the two products beyond five years. The supposition of constant product mix seems unrealistic as the products are substitutes as well as it is possible that one will be relatively more successful. The sales price has been increase in line with inflation but a lower sales price could be used in the decline stage to encourage sales.
Net working capital is to stay constant in nominal terms. In fact the level of working capital will depend on the value of goods, the working capital policies of the company, the credit offered to customers, the credit taken from suppliers etc. It is improbable that the constant real value will be maintained. The net present value is greatly dependent on the terminal value derived from the sale of fixed assets after five years. It is improbable that this value will be achieved in practice. It is as well possible that the machinery can be used to produce other products rather than be used solely to produce Alpha and Beta.