(a) Compute the optimal WC investment for the firm

Expected Growth in Estimated Cost of capital

WC as a % of revenue revenue (%) (%)
0 4.5 10.9
10 5 11
20 5.2 11.11
30 5.35 11.23
40 5.45 11.36
50 5.5 11.5
60 5.54 11.65
70 5.55 11.8
80 5.55 11.95
90 5.55 12.1
100 5.55 12.35

(b) Compute the optimal WC investment for the firm under the assumption that the current WACC (11.11%)
remains constant irrespective of the quantum of investment in WC by the firm.
Growth in Estimated Cost of capital
WC as a % of revenue Expected
revenue (%) (%)
0 4.5 11.11
10 5 11.11
20 5.2 11.11
30 5.35 11.11
40 5.45 11.11
50 5.5 11.11
60 5.54 11.11
70 5.55 11.11
80 5.55 11.11
90 5.55 11.11
100 5.55 11.11

(c) Compute the optimal WC investment for the firm under the assumption that the WACC keeps decreasing for
every increase in the quantum of investment in WC by the firm as stated below.
WC as a % of revenue Expected Growth in Estimated Cost of capital
revenue (%) (%)
0 4.5 12.5
10 5 11.72
20 5.2 11.11
30 5.35 10.6
40 5.45 10.2
50 5.5 9.9
 60 5.54 9.7
70 5.55 9.55
80 5.55 9.45
90 5.55 9.38
100 5.55 9.32
the firm

Expected Value of firm

1632.8125 Revenue 1000

1666.6666666667 EBIAT 100
1604.0609137056
1518.7074829932
Optimal WC as a % of revenue 10
1415.3976311337
1300
1183.3060556465
1067.2
955.46875
848.8549618321
736.0294117647

tion that the current WACC (11.11%)

ent in WC by the firm.
Expected Value of firm

1580.9379727685
1636.6612111293
Optimal WC as a % of revenue 10
1604.0609137056
1550.3472222222
1477.9151943463
1390.3743315508
1298.0251346499
1199.6402877698
1099.8201438849
1000
900.1798561151

n that the WACC keeps decreasing for

firm as stated below.
Expected Value of firm

1306.25
1488.0952380952
WC as a % of revenue 50
1604.0609137056
1700.9523809524
1761.052631579
1772.7272727273
1737.9807692308
1667.5
1567.9487179487
1451.6971279373
1327.5862068966
 Firm Inventory AR Other CA
BHEL 8,113 12,006 10,556
Bharat Elec 4,414 5,369 5,103
AIA Engine 458 901 182
Thermax 230 837 2471
NESCO 9 18 11
BEML 1,702 1,613 811
Greaves Co 115 337 41
Triveni Tur 217 173 37
GMM Pfau 103 49 22
KSB Ltd 303 291 72
Kirloskar oil engine 242 355 106
Praj Indust 104 228 160
Kirloskar Brothers 367 471 440

Sales Revenue Non-cash Working

Firm Ln(Revenue)
( in Rs cr) Capital/Rev
BHEL 29,349 10.29 42.80
Bharat Electronics 11,789 9.37 41.72
AIA Engineering 2,737 7.91 50.05
Thermax 3,488 8.16 8.74
NESCO 359 5.88 -14.48
BEML 3,458 8.15 73.11
Greaves Co 1,985 7.59 4.99
Triveni Turbine 811 6.70 18.62
GMM Pfaudler 412 6.02 13.35
KSB Ltd 1,078 6.98 27.37
Kirloskar oil engine 3,119 8.05 5.84
Praj Indust 904 6.81 9.73
Kirloskar Brothers 2,243 7.72 13.24
 Trade Payables Other CL Non-cash Working Capital
11,375 6738 12,562
1,435 8,533 4,918
152 19 1,370
799 2434 305
11 79 -52
762 836 2,528
319 75 99
119 157 151
53 66 55
218 153 295
382 139 182
189 215 88
537 444 297

Predicted Working Actual Working Capital (%) Under/over invested in Working

Capital (%) Capital
50.691 42.802 -7.889
40.958 41.717 0.759
25.375 50.055 24.680
27.962 8.744 -19.218
3.699 -14.485 -18.183
27.870 73.106 45.236
21.947 4.987 -16.960
12.395 18.619 6.224
5.168 13.350 8.181
15.432 27.365 11.933
26.769 5.835 -20.934
13.554 9.735 -3.819
23.251 13.241 -10.010
Overinvested
Underinvested
SUMMARY OUTPUT

Regression Statistics
Multiple R 0.5644197402
R Square 0.3185696431
Adjusted R Square 0.2566214288
Standard Error 20.2413971091
Observations 13

ANOVA
df SS MS
Regression 1 2106.961343401 2106.9613434
Residual 11 4506.8557261964 409.71415693
Total 12 6613.8170695973

Coefficients Standard Error t Stat

Intercept -59.0832012716 36.4975806254 -1.6188251456
Ln(Revenue) 10.6711642155 4.7056974887 2.2677114798
 F Significance F
5.1425153556 0.0444859259

P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

0.1337747376 -139.413834607 21.2474320642 -139.413834607 21.2474320642
0.0444859259 0.3139938751 21.028334556 0.3139938751 21.028334556
You are advising a small retailing firm that is thinking about making a significant change
in inventory policy. The firm currently has net working capital of $20 million on revenues of $100 million. It had net after-tax
inventory by 40%, but the change may adversely affect revenues. If the expected growth rate in the firm’s revenue and opera
the revenue have to drop for this change in inventory to negatively affect value?

Expected growth rate in revenue and EBIAT

Cost of capital
Reduction in Working Capital(Inventory)

Before Reduction in Inventory

Particulars Numbers (In million dollars)
Revenue $ 100.00
Net working capital $ 20.00
EBIAT $ 5.00
Change in WC $ 1.00
NOPAT $ 5.25
r-g 7%
EV of firm $ 60.71

The company needs to make 83.36 million to break even

 g a significant change
$20 million on revenues of $100 million. It had net after-tax operating income of $5 million. The firm is considering reducing its
f the expected growth rate in the firm’s revenue and operating income is 5% and the cost of capital is 12%, how much would
y affect value?

te in revenue and EBIAT 5%

of capital 12%
king Capital(Inventory) 40%

Increase in cash flow by

40% inventory cutback $ 8.00
Thus the firm value for break-even $ 52.71
Now if revenue is assumed R
Operating margin 5%
Operating income post tax 0.05*R
Change in WC 0.05*R*.12
FCFF R*0.05-0.05*R*.12
As per value of 52.71 FCFF/r-g
R 83.36
sidering reducing its
, how much would
SUMMARY OUTPUT

Regression Statistics
Multiple R 0.615504
R Square 0.378846
Adjusted R 0.309828
Standard E 0.115032
Observatio 11

ANOVA
df SS MS F Significance F
Regression 1 0.072635 0.072635 5.48915 0.043812
Residual 9 0.119092 0.013232
Total 10 0.191727

Coefficients
Standard Error t Stat P-value Lower 95%Upper 95%
Lower 95.0%
Upper 95.0%
Intercept -0.64261 0.445778 -1.44156 0.183303 -1.65104 0.365806 -1.65104 0.365806
X Variable 0.274478 0.117153 2.342894 0.043812 0.009459 0.539497 0.009459 0.539497
SUMMARY OUTPUT

Regression Statistics
Multiple R 0.015759
R Square 0.000248
Adjusted R -0.11084
Standard E 0.066515
Observatio 11

ANOVA
df SS MS F Significance F
Regression 1 9.89E-06 9.89E-06 0.002236 0.96332
Residual 9 0.039818 0.004424
Total 10 0.039828

Coefficients
Standard Error t Stat P-value Lower 95%Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.245301 0.257762 0.951656 0.366127 -0.3378 0.828398 -0.3378 0.828398
X Variable -0.0032 0.067741 -0.04728 0.96332 -0.15644 0.150039 -0.15644 0.150039
SUMMARY OUTPUT

Regression Statistics
Multiple R 0.569908
R Square 0.324796
Adjusted R 0.249773
Standard E 0.097459
Observatio 11

ANOVA
df SS MS F Significance F
Regression 1 0.041121 0.041121 4.329298 0.067189
Residual 9 0.085485 0.009498
Total 10 0.126606

Coefficients
Standard Error t Stat P-value Lower 95%Upper 95%
Lower 95.0%
Upper 95.0%
Intercept -0.49422 0.377678 -1.30857 0.223108 -1.34859 0.360149 -1.34859 0.360149
X Variable 0.206522 0.099256 2.080696 0.067189 -0.01801 0.431055 -0.01801 0.431055
SUMMARY OUTPUT

Regression Statistics
Multiple R 0.034457
R Square 0.001187
Adjusted R -0.10979
Standard E 0.058553
Observatio 11

ANOVA
df SS MS F Significance F
Regression 1 3.67E-05 3.67E-05 0.010699 0.919887
Residual 9 0.030856 0.003428
Total 10 0.030893

Coefficients
Standard Error t Stat P-value Lower 95%Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.163462 0.226908 0.720391 0.48957 -0.34984 0.676763 -0.34984 0.676763
X Variable -0.00617 0.059633 -0.10343 0.919887 -0.14107 0.128731 -0.14107 0.128731
 Firms Revenue Inventory Account Receivables
Dr. Reddy's Labs 10,863.90 2,015.60 3,717.70
Cipla 12,951.53 2,868.41 3,168.73
Ajanta Pharma 1,874.77 414.26 423.38
Lauras Labs 2,251.41 665.91 686.64
Lupin 11,647.66 2,305.98 3,724.32
Torrent Pharma 6,144.44 1,358.30 1,356.01
Glenmark 6,780.48 911.21 2,087.13
Divis Labs 5,036.24 1,663.18 1,282.24
Sun Pharmaceuticals 10360.27 2,792.62 5,031.47
Sanofi India 2,860.50 483.1 158.4
Aurobindo Pharma 12,457.11 3,971.26 5,232.07

Firms WC Deviation Inv Deviation AR Deviation

Dr. Reddy's Labs -528.37 -865.29 52.08
Cipla -743.51 -571.02 -1,404.95
Ajanta Pharma 203.97 -75.74 85.50
Lauras Labs 120.54 76.58 244.00
Lupin 454.17 -784.51 -278.34
Torrent Pharma -220.67 -263.48 -403.93
Glenmark 317.89 -879.90 85.26
Divis Labs 607.16 336.08 -70.66
Sun Pharmaceuticals -615.25 46.35 1,579.78
Sanofi India -577.91 -267.16 -465.27
Aurobindo Pharma 2,400.52 664.18 876.37
 Other CA Account Payables Other CL Non-Cash WC Ln(Revenue) WC as a % of Rev
972.3 1,031.60 1,316.70 4,357.30 4.03598576 40.11%
1,250.33 1,481.35 458.18 5,347.94 4.11232108 41.29%
111.63 185.53 102.9 660.84 3.27294800 35.25%
80.28 477.4 237.9 717.53 3.35245459 31.87%
1,262.48 1,254.02 251.31 5,787.45 4.06623868 49.69%
1,694.82 582.33 1,694.82 2,131.98 3.78848231 34.70%
1,886.33 1,667.66 224.63 2,992.38 3.83126044 44.13%
198.42 483.31 242.5 2,418.03 3.70210642 48.01%
2,462.23 2,154.92 4,145.13 3,986.27 4.01537107 38.48%
114.5 343.8 151.3 260.90 3.45644195 9.12%
1,119.40 1,841.39 278.76 8,202.58 4.09541730 65.85%

AP Deviation
-1,002.29
-949.31
-156.87
65.13
-928.72
-558.88
406.58
-449.47
216.59
-181.78
-495.22
Inv as a % of Rev AR as a % of Rev AP as a % of Rev Predicted WC Predicted Inventory
18.55% 34.22% 9.50% 4885.671336606 2880.8882284557
22.15% 24.47% 11.44% 6091.4502415606 3439.4290989178
22.10% 22.58% 9.90% 456.8738725702 489.9987735661
29.58% 30.50% 21.20% 596.990043341 589.3341989508
19.80% 31.97% 10.77% 5333.2823338113 3090.4875284039
22.11% 22.07% 9.48% 2352.6460023423 1621.7783111545
13.44% 30.78% 24.60% 2674.4946915186 1791.106523917
33.02% 25.46% 9.60% 1810.8744352585 1327.1022821344
26.96% 48.57% 20.80% 4601.5158880371 2746.2677923711
16.89% 5.54% 12.02% 838.8110950765 750.2582610199
31.88% 42.00% 14.78% 5802.0568245742 3307.0772689736
Predicted AR Predicted AP
3665.6218123735 2033.8949741468
4573.6792354129 2430.6644887014
337.8847109239 342.4036582793
442.6399167713 412.2663287409
4002.6620902412 2182.7415740847
1759.9356995649 1141.2123333854
2001.8665453808 1261.0849487004
1352.904903938 932.7752985613
3451.6942856876 1938.3259808453
623.6663540213 525.5844132239
4355.7028017122 2336.6113127683
 Table 4

1996 1997 1998

Margin =(EBIT/Sales) 4.4% 4.9% 6.2%
Capital Turnover =(Sales/Invested capital) 2.73 3.21 4.04
Pretax ROIC=(EBIT/Invested Capital) 12% 16% 25%
Financial leverage multiplier = Pretax ROE / Pretax ROIC 1.198327 1.009056 0.861850
Pretax ROE=(EBT/Equity) 14% 16% 22%
Tax Effect=(1-tax rate) 0.835 0.835 0.835
After tax ROE = (EAT/ Equity) 12% 13% 18%
b=Retention rate=(RE/Earning after tax) 0.333333 0.079426 0.369594
Sustained growth rate= b*ROE 4% 1% 7%
 Table 5

1996 1997 1998

After tax ROIC = Pretax ROIC *(1-tax) 0.10016 0.13142 0.20959
WACC 0.13680 0.13732 0.16464
After tax return spread -0.03664 -0.00590 0.04495
Invested Capital 62.77500 58.39000 60.59600
EVA -2.29991 -0.34453 2.72366

1996 1997 1998

Debt 24.14 23.78 31.094
Equity 38.75 39.165 41.986
Debt ratio 0.383844808 0.377790134 0.425478927
Equity ratio 0.616155192 0.622209866 0.574521073
Equity rate 0.17 0.17 0.2
Debt rate 0.0835 0.0835 0.1169
WACC 0.136797424 0.137321153 0.164642701
 Table 6

Great Eastern Company A Company B Company C

Current Ratio = CA/CL 1.51 1.7 2 1.6
Short term debt/(ST debt+LT debt) 0.89 0.6 0.75 0.65
Average Collection period 50 32 29 30
Average payment period 37 30 32 37
Inventory Turnover 4.4 8 10 9
Pretax operating profit Margin 6% 6.0% 6.8% 6.5%
Invested capital turnover 4.042 3.42 4.13 3.72
ROIC 25% 21% 28% 24%
Financial leverage multiplier 0.861 0.898 0.875 0.905
ROE 22% 18% 25% 22%
Tax effect(1-tax rate) 0.840 0.850 0.840 0.840
ROE(after tax) 0.185 0.156 0.207 0.184