part II OF Measuring liquidity in better way .pdf

unit 1-Measuring liquidity part 2

1. CORPORATE FINANCE
ABHIJEET CHANDRA
Vinod Gupta School of Management, IIT KHARAGPUR
Lecture 29: Measuring Liquidity -IINPTEL

2. CONCEPTS COVERED
⮚Net Operating Cycle
⮚Working Capital and Firm ValueNPTEL

3. Inventory period Accounts receivable period
Accounts payable period
Stock arrives
Cash received
Order placed
Firm receives
invoice
Cash paid for
materials
Operating cycle
Cash cycle
Measuring Liquidity
Operating CycleNPTEL

4. Example:Fromthebalancesheetofacompany,weobtainthefollowinginformation(in
Rs.Lakh).
Sales revenue 56,940
Cost of Goods Sold 44,754
Accounts Receivables 9,842
Inventory 1,382
Accounts Payables 15,223
Cash Conversion Cycle ??
Measuring Liquidity
Operating CycleNPTEL

5. Measuring Liquidity
Liquidity Ratios
Source: Berket al. (2021)NPTEL

6. Working Capital and Firm Value
•For evaluating the project, we estimate the free cash flows that are usually available for
serving both equity shareholders and debt holders.
•FCFs exclude debt flows (interest charges and principal re-payments).
•FCF is calculated as following:
FCF = EBIT (1 –t) + Dep. –ΔNWC -CapEx
Why working capital can increase/decrease firm value?
Earnings before Interest and Taxes (EBIT)
Less: Taxes
Add: Depreciation
Less: Changes in Working Capital
Less: Capital expenditure
Free Cash Flow Unlevered Cash FlowsNPTEL

7. Working Capital and Firm Value
Example:EmeraldCityexpectscapitalexpendituresanddepreciationtocontinuetooffset
eachother,andforbothnetincomeandincreaseinworkingcapitaltogrowat4%per
year.EmeraldCity’scostofcapitalis12%.IfEmeraldCitywereablereduceitsannual
increaseinworkingcapitalby20%bymanagingitsworkingcapitalmoreefficiently
withoutadverselyaffectinganyotherpartofthebusiness,whatwouldbetheeffect
onEmeraldCity’svalue?
Why working capital can increase/decrease firm value?
Earnings before Interest and Taxes (EBIT) 20,00,000
Less: Taxes Nil
Add: Depreciation +5,00,000
Less: Changes in Working Capital -5,00,000
Less: Capital expenditure -1,00,000
Free Cash Flow 19,00,000
Unlevered
Cash Flows
r
WACC= 12%
g = 4%NPTEL

8. Working Capital and Firm Value
Example:
Why working capital can increase/decrease firm value?
Earnings before Interest and Taxes (EBIT) 20,00,000
Less: Taxes Nil
Add: Depreciation +5,00,000
Less: Changes in Working Capital -5,00,000
Less: Capital expenditure -1,00,000
Free Cash Flow 19,00,000
r
WACC= 12%
g = 4%NPTEL

9. Working Capital and Firm Value
Example:
Why working capital can increase/decrease firm value?
Earnings before Interest and Taxes (EBIT) 20,00,000
Less: Taxes Nil
Add: Depreciation +5,00,000
Less: Changes in Working Capital -5,00,000
Less: Capital expenditure -1,00,000
Free Cash Flow 19,00,000
r
WACC= 12%
g = 4%
IfEmeraldCitywereablereduceitsannualincreaseinworkingcapitalby20%by
managingitsworkingcapitalmoreefficientlywithoutadverselyaffectingany
otherpartofthebusiness:NPTEL

10. CONCLUSION
•Operating cycle is calculated as the total of number of days required for
accounts receivablesand inventory..
•Net operating cycle shows the net of number of days in operating cycle minus
the number of days in accounts payables.
•Management of working capital can be looked upon as a tool to enhance
value of the firm.NPTEL

11. REFERENCES
⮚Corporate Finance, 2
nd
ed. (2012), Claymanet al. Wiley
⮚Financial Management, 14
th
ed (2021), Pandey, PearsonNPTEL

12. NPTEL