Page 219 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes Texas Electronics Inc.: Effect of Stock Repurchase
Item Before repurchase After repurchase
Total current earnings ` 13.2 crore ` 13.2 crore
Shares outstanding 11.0 crore 10.3 crore
Earnings per share ` 1.20 ` 1.32
Price earnings ratio 7.50 7.50
Price ` 9.00 ` 9.90
Current ratio 2.57 2.29
a
Total debt to total assets 40% 43%
b

a the before ratio is 90/35 = 2.57, and the after ratio is (90-9.9)/35=2.29
b The before ratio is 52/130 = 40%, and the after ratio is 52/(130-9.9) = 43%
The equilibrium repurchase price is given by

Equilibrium repurchase price = current price + equivalent amount if cash dividend is paid.
For Texas Electronics, the equilibrium repurchase price is ` 9.00 + 0.90 or ` 9.90 per share.
Today, it is generally accepted that dividend policy is value neutral.

Self Assessment

Fill in the blanks:

1. ............................. investment creates the need for additional investment in inventory,
accounts receivable and cash.
2. Investment is the change in ............................. stock during a period.

3. If all capital is circulating capital, then ............................. capital built up during the previous
period can be brought over into next period.
4. ............................. is the rate of growth a project is expected to generate.

5. Firms that are regarded as being of both high long-term and high short-term credit quality,
have ............................. stocks of inventories and financial working capital.
6. By retaining ............................., firms accumulate the financial funds needed for investment.

13.2 Working Capital Decisions vs Capital Investment Decisions

As we already know, working capital is the amount of capital which is readily available to an
organization. That is, working capital is the difference between resources in cash or readily
convertible into cash (Current Assets), and cash requirements (Current Liabilities). As a result,
the decisions relating to working capital are always current, i.e. short-term decisions.
In addition to time horizon, working capital decisions differ from capital investment decisions in
terms of discounting and profitability considerations; they are also “reversible” to some extent.
Working capital management decisions are therefore not taken on the same basis as long term
decisions, and working capital management applies different criteria in decision making: the
main considerations are:
1. Cash flow/liquidity and

2. Profitability/return on capital

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