Final answer:
The project's incremental free cash flows include the initial investment of $300,000 in net working capital, which does not impact the free cash flows until it is recovered at the end of the project. This recovery is considered a cash inflow that must be included in the final calculation of the project's free cash flows.
Step-by-step explanation:
The project's incremental free cash flows can be defined as the cash flows that are directly attributable to the project in question, separate from the company's other operations. When considering an initial investment in net working capital of $300,000, it is important to note that this investment is not an expense but rather it is a use of cash that is expected to be recovered at the end of the project. In the years leading up to the recovery, the net working capital will not impact the free cash flows since it remains constant. However, at the end of year 2, when the net working capital is recovered, this will generate a positive incremental free cash flow, as this money is returned to the firm.
Reinvesting in net working capital is key for a business to maintain its operations and support growth, as it ensures the company has the funds necessary to continue operating on a day-to-day basis. Importantly, the recovery of net working capital at the end of the project should be included in the project's incremental free cash flow calculations as a cash inflow.
To summarize, the investment in net working capital will temporarily remove cash from the company's free cash flow, but will return as a cash inflow when the working capital is recovered at the end of the project, thus generating incremental free cash flow at that time.