Page 229 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes  On identifying the costs and benefits created by the working capital components and
linking them explicitly to the total investment planning process, we analyse certain very
important points.
 In the early life of an investment, it is operating below capacity, while later in the life
cycle, there is often an increase in the operating capacity.

 The discounted cash flows related to cash, receivables, and inventories can range from a
modest to the major proportion of the total cost of an investment.
 The need for additional investment in working capital is dependent on the type and size
of investment, the size and growth of the market, the growth of the relative market share
and length of the planning horizon.

13.5 Keywords

Decision Tree: A graph or model of decisions and their possible consequences, including chance
event outcomes, resource costs, and utility.

Discounted Payback Period: Length of time required to recover the initial cash outflow from the
discounted future cash inflows.
IRR: Stands for Internal Rate of Return. IRR is the rate of growth a project is expected to generate.

Real Options Analysis: A useful tool for stimulating thinking about a range of possible options
and helping to make decisions on what to invest in. In particular, ROA helps to keep investment
options open, and enable riskier approaches to be explored, without making long-term
commitments to them.

13.6 Review Questions

1. How should companies address working capital management following global changes
in the economy and in industry structures?
2. The Mobile Company receives the following cheques during January. Calculate the amount
of opportunity costs for January for Mobile if the opportunity cost rate is 12% per annum.
Face Amount Days Delay
1,00,000 4
1,50,000 5
50,000 3

75,000 6
3. Assume that a cash manager discovers that his firm is paying off its accounts payable at an
average of two days early. If the firm changes this practice and pays the accounts on their
due date, what is the effect on the disbursement float if credit purchases are ` 9.125 crore
annually? If the available cash released can be invested in short-term securities at 10 per
cent and the firm’s tax rate is 40 per cent, what is the net benefit to the firm? Assume a
365-day year.

4. R.J. Mahajan, financial manager of the AMC Services, has been keeping the firm’s fund in
the First Growth Fund (FGF) a money market fund that pays 8 percent on deposits and has
no charge for withdrawals. Mahajan has found another Fund, Grand Growth fund that pay

224 LOVELY PROFESSIONAL UNIVERSITY