Which of the following two companies creates more value, assuming that they are making the same initial investment?

Profits for both companies are 20 per cent of sales in each year. With company A, for every £1 increase in sales 7p has to be devoted to additional debtors because of the generous credit terms granted to customers. For B, only 1p is needed for additional investment in debtors for every £1 increase in sales. Higher sales also mean greater inventory levels at each firm. This is 6p and 2p for every extra £1 in sales for A and B respectively.

Apart from the debtor and inventory adjustments the profit figures of both firms reflect their cash flows. The cost of capital for both firms is 14 per cent.

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Company A's projected profits Company B's projected profits Year Profit (000s) Year Profit (000s) Last year 1,000 Last year 1,000 1 (forthcoming year) 1,000 1 (forthcoming year) 1,000 23456 2 1,100 2 1,080 3 1,200 3 1,160 4 1,400 4 1,350 1,600 5 1,500 6 and all subsequent years 1,800 6 and all subsequent years 1,700