FM-II-Classroom Exercise- WCM (XL-BM-2019)

1. Given below is the data on CA & CL of BHEL for the FYs ending on 31 March 2015-2019 ( in
Rs.cr)

Current Assets Mar 19 Mar 18 Mar 17 Mar 16 Mar 15

Inventories 8,113.49 6,258.76 7,372.38 9,602.15 10,101.66

Trade Receivables 12,009.57 22,771.49 22,075.56 22,430.12 26,223.50
Cash And Cash 7,503.34 11,291.18 10,491.79 10,085.99 9,812.70
Equivalents
Short Term Loans 157.45 147.12 138.88 176.61 2,224.65
And Advances
OtherCurrentAssets 10,556.04 2,719.84 2,815.35 2,830.41 175.03
Total Current 38,339.89 43,188.39 42,893.96 45,125.28 48,537.5
Assets

Current Mar 19 Mar 18 Mar 17 Mar 16 Mar 15

Liabilities

Short Term 2,457.27 0.00 0.00 0.00 0.00

Borrowings
Trade 11,375.11 10,586.86 8,709.16 8,698.34 8,798.94
Payables
Other Current 6,737.91 7,880.60 7,224.95 8,689.32 9,123.31
Liabilities
Short Term 2,485.48 3,782.77 4,191.56 3,335.90 4,285.23
Provisions
Total Current 23,055.77 22,250.23 20,125.67 20,723.56 22,207.48
Liabilities

Compute

Mar 19 Mar 18 Mar 17 Mar 16 Mar 15

(a) Working
Capital
(b) Working
Capital
as a% of
Sales
Revenue

Sales Revenue 29,349.21 27,963.15 27,587.64 26,050.07 29,541.97

Compute

Mar 19 Mar 18 Mar 17 Mar 16 Mar 15

(a) Non-Cash
Working
Capital
(b) Non-Cash
Working
Capital as
a% of
Sales
Revenue
 Sales Revenue 29,349.21 27,963.15 27,587.64 26,050.07 29,541.97
2. Assume that we are analyzing a hypothetical capital budgeting proposal (project). We expect
that the working capital investment would be 20% of revenues and that the WC investments
would occur at the beginning of each year in which we would anticipate a change in WC.it is
also assumed that the entire WC would be salvaged at the end of the project life.
Compute the impact of the WC investment on the NPV of the project with the following data
(Assume 10% as cost of capital for the project) (amount in Rs million)

Year Revenue Working Capital Change in Salvage PVIF Present

Investment(20 WC(Previous value value(WC
% of next year) Year – (Ultimate * PVIF)
Current Year years’
WC) WC)
0 0 0 0 1
1 0 0 0 1 by 1.1
2 0 2000 2000 1 by
1.1^2
3 10,000 2400 400

4 12,000 2800 400

5 14,000 3200 400
6 16,000 4000 800
7 20,000 3800 200
8 19,000 3600 200
9 18,000 3400 200
10 17,000 3200 200
11 16,000 3000 200
12 15,000 Here WC is 3000
happening at
Beginning of
the year

3. You are requested to compute the optimal WC as a % of revenue for a hypothetical firm that
currently maintains a non-cash WC @ 20% of revenues. The firm currently has revenues of
INR 1000 million and after tax operating income (EBIAT) of Rs 100 million and it expects
5.20% growth rate in revenue on a perpetual basis. The firm’s present WACC is 11.11%. The
finance manager has estimated the cost of capital and growth rate in revenues at various
levels of WC (from 0% to 100%)

WC as a Expected Estimated Expected Value of firm(Comparable Firm’s

% of Growth in Cost of Approach)
revenue revenue capital
(%) (%)
0 4.50 10.90
10 5.00 11.00
20 5.20 11.11
30 5.35 11.23
40 5.45 11.36
 50 5.50 11.50
60 5.54 11.65
70 5.55 11.80
80 5.55 11.95
90 5.55 12.10
100 5.55 12.35

(a)Compute the optimal WC investment for the firm.

(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.

WC as a Expected Estimated Expected Value of firm

% of Growth in Cost of
revenue revenue capital
(%) (%)
0 4.50 11.11
10 5.00 11.11
20 5.20 11.11
30 5.35 11.11
40 5.45 11.11
50 5.50 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 Expected Estimated Expected Value of firm

% of Growth in Cost of
revenue revenue capital
(%) (%)
0 4.50 12.50
10 5.00 11.72
20 5.20 11.11
30 5.35 10.60
40 5.45 10.20
50 5.50 9.90
60 5.54 9.70
70 5.55 9.55
80 5.55 9.45
90 5.55 9.38
100 5.55 9.32
4. The table below presents the Inv, AR, other CA, Trade Payables & Other CL for BHEL and its
peers for the latest financial year. Compute Non-Cash WC for the firms.

Firm Inventory AR Other CA Trade Other CL Non-cash

Payables WC
BHEL 8,113 12,006 10,556 11,375 6738
Bharat 4,414 5,369 5,103 1,435 8,533
Elec
AIA Engine 458 901 182 152 19
Thermax 230 837 2471 799 2434
NESCO 9 18 11 11 79
BEML 1,702 1,613 811 762 836
Greaves 115 337 41 319 75
Co
Triveni Tur 217 173 37 119 157
GMM Pfau 103 49 22 53 66
KSB Ltd 303 291 72 218 153
Kirloskar 242 355 106 382 139
oil engine
Praj Indust 104 228 160 189 215
Kirloskar 367 471 440 537 444
Brothers

Given the sales revenue , regress Non-Cash WC as a % of revenue against ln Sales revenue
for the firms and conclude on which firms are under/over invested in their Non-cash WC

Firm Sales Ln Reve Non-cash Predicted Actual Under/over

Revenue WC/Rev WC WC invested in
( in Rs cr) ( in %) WC
BHEL 29,349
Bharat 11,789
Electronics
AIA 2,737
Engineering
Thermax 3,488
NESCO 359
BEML 3,458
Greaves Co 1,985
Triveni 811
Turbine
GMM 412
Pfaudler
KSB Ltd 1,078
Kirloskar oil 3,119
engine
Praj Indust 904
Kirloskar 2,243
Brothers

5. (Taken from Ch.13 of Prescribed Text Book-Problem no.5)

 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 operating income of $5 million. The firm is considering
reducing its inventory by 40%, but the change may adversely affect revenues. If the expected
growth rate in the firm’s revenue and operating income is 5% and the cost of capital is 12%,
how much would the revenue have to drop for this change in inventory to negatively
affect value?
6. (Taken from Ch.13 of Prescribed Text Book-Problem no.8& 9)
You are analyzing the inventory policy of High Tech Retail, a retailer of stereo systems. You
are given with the following data
 Annual expected sales (in units)= 18000
 Cost of placing a new order ( takes a month to receive delivery) = $1000
 The interest rate (foregone on inventory) is 10% and each stereo cost about
$1000.Other storage and administrative costs, on an annual basis, will account to $100
per unit
 The standard deviation in expected sales in units = 4000
 The firm wants to ensure ,with 99% probability, that it does not run out of inventory.
Compute the following
(a) Optimal order quantity for the firm
(b) Safety inventory (consider only deliver lag)
(c) Average inventory ( consider only delivery lag)
(d) Safety inventory ( consider both delivery lag & uncertainty)
(e) Average inventory ( consider both delivery lag & uncertainty)
7. ( Taken from Ch.13 of Prescribed Text Book-Problem no. 10)
Dress mart, a clothing retailer currently has after-tax operating income of $100 million on
revenues of $1 billion and expects operating income to grow 4% in perpetuity. The firm
currently maintains non-cash WC @ about 15% of revenues and has a 11% WACC. The firm is
considering increasing its product offerings. If it does so, the expected growth rate will jump
to 5% a year in perpetuity, but non- cash WC will be 20% of revenues. If the cost of capital
will remain unchanged, should the firm increase its product offerings?
8. In Practice 13.9 (prescribed textbook)
Inventory holding: home improvement stores

Company Name Inventory/sales (%) Ln (sales revenue) Standard deviation

in operating
earnings (%)
Building Materials 10.74 6.59 35.82
Catalina Lighting 17.46 5.09 52.76
Continental Material 14.58 4.59 25.15
Eagle Hardware 20.88 6.88 45.50
Emco Ltd 16.50 7.14 39.68
Fastenal co. 19.96 5.99 43.41
The Home Depot 14.91 10.09 24.15
Homebase Inc. 21.27 7.30 36.93
Hughes Supply 18.43 7.54 35.90
Lowe’s co 16.91 9.22 33.72
National Home 12.72 5.02 70.93
Waxman Industries 24.76 4.66 112.57
Westburne Inc. 14.79 7.76 25.14
 Wolohan Lumber 9.24 6.05 24.56

Regress Inv/sales as a dependent variable and ln (sales) and SD in EBIT as independent

variables and using the output find out which firms are over/under invested in Inventory.
9. In practice 13.10 (prescribed textbook)
Stereo city, an electronics retailer, has historically not extended credit to its customers and
has accepted only cash sales. In the current year, it had revenues of $10 million and pre-tax
operating income of $2 million. If the firm offers 30 day credit to its customers, it expects the
following changes
 Incremental sales of $1 million per year with pre-tax EBIT @ 20% on incremental sales
 The store is expected to charge an annualized interest rate of 12% on these credit sales
 Bad debt is expected to be 5% of the incremental credit sales
 The cost of administration associated with credit sales is expected to be $25,000 per
year
 Initial investment in computerized credit tracking system of $1,00,000 (depreciable life
of 10 years-SLM of depreciation)
 Tax rate=40%
 The store is expected to be in business for 10 years ; at the end of that period, 95% of
accounts receivable will be collected.
 Cost of capital for the store is 10%

WHETHER THE FIRM SHOULD OFFER CREDIT SALES?

PVIFA = [ 1- 1/(1+r)^n] / r

10. ( Taken from Ch.13 of Prescribed Text Book-Problem no. 13)

You are considering offering your customers a 2% discount if they pay cash on their
purchases within 10 days; if they do not pay cash, the balance will be due within 50 days.
(a) Estimate the annualized implied interest rate the credit customers being charged
(b) If customers take 100 days instead of 50 days to make payment, then ,what is the
revised annualized implied interest rate

11. ( Taken from Ch.13 of Prescribed Text Book-Problem no. 14)

You are considering using trade credit as a way of reducing working capital needs. You
currently receive a 2% discount because you pay in 30 days, but you could give up the
discount and pay in 90 days. You purchase $100 million worth of supplies ( before the 2%
discount) every year and your cost of capital is 10% and tax rate is 40%
(a) Estimate the increase in accounts payable, if you go to the 90-day payment period from
the present 30 days
(b) With your current cost of capital, will using trade credit increase or decrease value?
( you can assume that your purchases will grow 4% a year forever)
(c) How would your answer change if this change caused your bond rating to drop one
notch and your cost of capital to increase?