Concepts and Determination

of Working Capital UNIT 4 THEORIES AND APPROACHES

Objectives

The objectives of this unit are:

• To provide you an understanding as to the policy making in the area of
working capital management.
• To examine the different approaches to working capital management.
• To highlight the impact of different choices of investment and financing on
working capital policy.
Structure
4.1 Introduction
4.2 Creation of Value through Working Capital Management
4.3 Approaches to Working Capital Investment
4.4 Approach to Financing Working Capital
4.5 Effect of Choice of Financing on ROI
4.6 Summary
4.7 Key Words
4.8 Self-Assessment Questions
4.9 Further Readings

4.1 INTRODUCTION
In the previous unit, we have discussed about the concept of operating cycle and
various methods for determining working capital requirements. The present unit
focuses on the theoretical issues governing the determination and also the
practices followed by banks and other financial institutions. This is expected to
help the Student come closer to the reality. There has been little difficulty in
segregating the issues under this block into individual units due to their
overlapping content. Therefore, an attempt has been made in this unit to cover all
those issues that could not be covered under the earlier three units, yet focussing
on the theme of the present unit. As you could observe from the structure of the
lesson presented above, enough care has been taken to include only pertinent
matters in the discussion that follows. Major concentration has been on the
following:
a) What is the objective function in taking working capital decisions?
b) How to create value through working capital?
c) Is there any scope to lay down time-tested principles of working capital
policy?
d) How do risk-return relationships operate in the area of working capital
decision making?

4.2 CREATION OF VALUE THROUGH WORKING

CAPITAL MANAGEMENT
Creation of value has been said to be the objective of a company. In the realm
of finance it turns out to be the function of firm’s investment, financing and
dividend decisions. In addition to long term investment decisions, companies face
many decisions involving investment in current assets. Quite often, maximisation
54
of profits is regarded as the proper objective of the firm. but it is not as inclusive Theories and Approaches
as that of maximising shareholders’ value. A right kind of approach to decisions
of investment and financing of working capital can contribute to the achievement
of the objective function.

Value maximisation is considered consistent with the interests of various groups

that interact with the business. Take for instance shareholders; businesses can
often do what individuals cannot do on their own. Business houses pool up
resources and engage in mass production, which is beyond the capacity of an
individual as shareholder. Perpetual succession ensures enough confidence to a
creditor. The point of view of society is well taken care of, since there is a
realisation on the company that it cannot pursue profit maximisation as a goal. A
framework is thus created for analysing the financial decisions from the
standpoint of maximising value.

Be that as it may, how should one proceed to create value through working
capital management. The answer is: invest in an asset, if its net present value is
positive. The fact is that the basic principles of long term asset investment
decisions should apply equally well to short term asset investment decisions.
Therefore, it is useful to examine this criterion more closely in terms of current
asset investment decisions.

The general formula for finding net present value of a project is:
A1 A2 A3 An
NPV= ————— 1
+ ————— 2
+ ————— 3
+ ------- + ———— – C
(1+K) (1+K) (1+K) (1+K)n
Where A1 to An represent annual cash inflows on an after tax basis. ‘K’ is the
discount factor, which is generally taken as the cost of capital. ‘C’ represents the
initial outflow.

This equation can be used to decide the choice of investment in current assets
taking into account their shorter life span. Accepting one year life as standard to
categorise assets into fixed and current, NPV has to be calculated for each year.
For this purpose, the above equation can be modified as follows to elicit NPV.
A1 A2 A3 An
NPV =—— + ——— + ——— + ------- + ——— – C
K K K K
Like the decisions in capital budgeting, the problem remains as that of
determination of risk and thus the appropriate discount rate to apply.

Sometimes, practitioners tend to use net profit criterion to decide the investment
in current assets; which they consider is a simple modification of the concept of
NPV as shown below:
r
Net profit per period = Annuity = NPV [———— ]
1–(1+ r)–n
Example 4.1

There is an investment proposal involving Rs.5000 initial investment and

generating Rs.500 per year, so long as we keep the investment intact. The NPV
in this case depends on the discount rate and time period assumed. We may also
calculate an annuity that has a present value equal to the NPV of above
investment using the above equation. Assuming that the discount rate is 8%. Net
profit per period will be Rs.100. See the following derivation:
r
Net Profit = Annuity = NPV (—————)
per period 1- (1+r)–n

55
Concepts and Determination 500 500 5000 r
of Working Capital = [–5000 + ———— + ———— n
+ ————— n
] [—————]
(1+ r) (1+ r) (1+ r) 1–(1+ r)–n

1–(1+ r)–n
r
= 500 (—————) (——————)
r
1-(1+ r)–n

r
– [ 5000 – 5000 (1+r)–n ] (—————)
1–(1+r)–n

1-(1+ r)–n 1/r

But ——————— = —————————.
r
1–(1+ r)–n
r
So Net Profit = 500 – 5000 [1– (1+ r )–n ] (——————)
1–(1+ r)–n
= 500 – 5000 (r)
= 500 – 5000 (8%)
= 500 – 400 = 100
The Rs.400 is the annual capital cost of Rs.5,000 investment at an 8 per cent
rate of interest, and the annual net profit of Rs. 100 does not depend on when
the investment is reversed. The result is that we can use net profit per period as
a criterion for choosing among alternative reversible investments. The investment
with the highest value of net profit per period is also the investment with the
highest net present value, regardless of when the investment is reversed.
Investments with positive NPVs will have positive net profits, investments with
zero NPVs will have zero net profits, and investments with negative NPVs will
have negative net profit. Thus, net profit per period, instead of NPV can be used
as a decision criterion for working capital management.

Many current asset decisions, particularly inventory decisions, can be made on

the basis of minimising cost. There also, instead of minimising the net present
value of costs. One may minimise total annual cost where the annual capital cost
of the investment is the discount rate times the amount invested. In sum the
current assets may be treated as reversible and investment policies may be
selected that maximise net profit or minimise total cost per period. The choice
between the profit or cost criterion will of course depend on the particular
problem being analysed.

4.3 APPROACHES TO WORKING CAPITAL

INVESTMENT
Every business enterprise needs to pay particular attention towards the planning
and control of working capital. Different approaches have been suggested for this
purpose. Of them, let us focus our attention on the following two approaches:
i) Walker’s approach
ii) Trade off approach

4.3.1 Walker’s Approach

Early in 1964 Ernest W. Walker has developed a four-part theory of working
capital. He has laid down that a firm’s profitability is determined in part by the
way its working capital is managed. When the working capital is varied relative
to sales without a corresponding change in production, the profit position is
56
affected. If the flow of funds created by the movement of working capital is Theories and Approaches
interrupted, the turnover of working capital is decreased, as is the rate of
return on investment. In this regard. Walker has laid down the following four
principles with respect to working capital investment.

First principle: This is concerned with the relation between the levels of
working capital and sales. His principle is that: if working capital is varied
relative to sales, the amount of risk that a firm assumes is also varied and the
opportunity for gain or loss is increased. This implies that a definite relation
exists between the degree of risk that management assumes and the rate of
return. The more the risk that a firm assumes, the greater is the opportunity
for gain or loss. Consider the following data:

Table 4.1: XYZ Manufacturing Company

1 2 3
Level of working capital (Rs.) 50,000.00 90,000.00 1,20,000.00
Fixed capital (Rs.) 10,000.00 10,000.00 10,000.00
Liabilities 30,000.00 30,000.00 30,000.00
Net Worth 30,000.00 70,000.00 1,00,000.00
Sales 1,00,000.00 1,00,000.00 1,00,000.00
Fixed Capital Turnover 10.00 10.00 10.00
Working Capital Turnover 2.00 1.1 0.8333
Total Capital Turnover 1.66 1.00 0.761
Earnings (as Percent of Sales) 10.00 10.00 10.00
Rate of Return (Percent) 16.60 10.00 7.60
————————————————————————————————
It can be seen from the data that the return on investment has increased from
7.6 percent to 16.6 per cent when working capital fell from Rs. 1,20,000 to
Rs.50,000. Moreover, it is believed that while the potential gain resulting from
each decrease in working capital is greater in the beginning than potential loss,
exactly opposite occurs, if the management continues to decrease working
capital (see-Figure 4.1).

Fig. 4.1: Working Capital Relative to Sales

Gain
Rate of Raturn

0
Loss

Decreasing Level of Working Capital per Unit of Sales 57

Concepts and Determination It is also presumed that by analysing correctly the factors determining the amount
of Working Capital of the various components of working capital as well as predictions of the state
of the economy, management can determine the ideal level of working capital
that will equilibrate its rate of return with its ability to assume risk. However,
since most managers do not know what the future holds, they tend to maintain
an investment in working capital that exceeds the ideal level. It is this excess
that concerns us, since the size of the investment determines a firm’s rate of
return on investment.

Second principle: Capital should be invested in each component of working

capital as long as the equity position of the firm increases. This principle is based
on the concept that each rupee invested in fixed or working capital should
contribute to the net worth of the firm.

Third principle: The type of capital used to finance working capital directly
affects the amount of risk that a firm assumes as well as the opportunity for
gain or loss and cost of capital. It is indisputable that different types of capital
possess varying degrees of risk. Investors relate the price for which they are
willing to sell their capital to this risk. They may charge less for debt than equity,
since debt capital possesses less risk. Thus risk is related to the return. Higher
risk may imply a higher return too. Unlike rate of return, cost of capital moves
inversely with risk. As additional risk capital is employed by management, cost of
capital declines. This relationship prevails until the firm’s optimum capital structure
is achieved.

Fourth principle: The greater the disparity between the maturities of a firm’s
short-term debt instruments and its flow of internally generated funds, the greater
the risk and vice-versa. This principle is based on the analogy that the use of
debt is recommended and the amount to be used is determined by the level of
risk, management wishes to assume. It should be noted that risk is not only
associated with the amount of debt used relative to equity, it is also related to the
nature of the contracts negotiated by the borrower. Some of the more important
characteristics of debt contracts directly affecting a firm’s operation are
restrictive clauses of the contracts and dates of maturity.

Lenders of short-term funds are particularly conscious of this problem, and in an

effort to protect them selves by reducing the risk associated with improper
maturity dates, they are requiring firms to produce documents depicting cash
flows. These documents when properly prepared, not only show the level of
loans necessary to support sales but also indicate when the loans can be repaid.
In other words, lenders realize that a firm’s ability to repay short-term loans is
directly related to cash flow and not to earnings, and therefore, a firm should
make every effort to the maturities to its flow of internally generated funds.

4.3.2 Trade off Approach

It is evident from the study of Walker’s principles that working capital decisions
involve a trade-off between risk and return. The same is sought to be further
examined in this section.

All decisions of the financial manager are assumed to be geared to maximisation

of shareholders wealth, and working capital decisions are no exception.
Accordingly. risk-return trade-off characterises each of the working capital
decision. There are two types of risks inherent in working capital management,
namely, liquidity risk and opportunity loss risk. Liquidity risk is the non-availability
of cash to pay a liability that falls due. Even though it may happen only on
certain days, it can cause, not only a loss of reputation but also make the work
condition unfavourable for getting the best terms on transaction with the trade
58
creditors. The other risk involved in working capital management is the risk of Theories and Approaches
opportunity loss i.e. risk of having too little inventory to maintain production and
sales, or the risk of not granting adequate credit for realising the achievable level
of sales. In other words, it is the risk of not being able to produce more or sell
more or both, and therefore, not being able to earn the potential profit, because
there are not enough funds to support higher inventory and book debts. Thus, it
would not be out of place to mention that it is only theoretical that the current
assets could all take zero values. Indeed, it is neither practicable nor advisable. In
practice, all current assets take positive values, because firms seek to reduce
working capital risks.

The risk-return trade-off involved in managing the firm’s liquidity via investing in
marketable securities is illustrated in the following example. Firms A and B are
identical in every respect but one. Firm B has invested Rs.5,000 in marketable
securities which has been financed with equity. That is, the firm sold equity
shares and raised Rs.5,000.00. The balance sheets and net incomes of the two
firms are shown in Table 4.2. Note that Firm A has a current ratio of 2.5
(reflecting net working capital of Rs. 15,000) and earns a 10 percent return on
its total assets. Firm B, with its larger investment in marketable securities has a
current ratio of 3 and has net working capital of Rs.20,000. Since the marketable
securities earn a return of only 9 percent before taxes (4.5 percent after taxes
with a 50 percent tax rate). Firm B earns only 9.7 percent on its total
investment. Thus, investing in current assets and in particular in marketable
securities, does have a favourable effect on firms liquidity but it also has an
unfavourable effect on the firm's rate of return earned on invested funds. The
risk-return trade-off involved in holding more cash and marketable securities,
therefore, is one of added liquidity versus reduced profitability.

Table 4.2 : The Effects of Investing in Current Assets on Liquidity and Profitability

Balance Sheets A B

Cash Rs 500 Rs 500

Marketable securities ——- 5,000
Accounts receivable 9,500 9,500
Inventories 15,000 15,000
Current assets 25,000 30,000
Net fixed assets 50,000 50,000
Total 75,000 80,000
Current liabilities 10,000 10,000
Long-term debt 15,000 15,000
Capital Equity 50,000 55,000
Total 75,000 80,000
Net Income 7,500 7,725*
Current ratio 25,000 30,000
(Current assets/ ———— = 2.5 times ————— =3.0 times
Current liabilities) 10,000 10,000
Net working capital 15,000 20,000
(Current assets-Current liabilities) 7,500 = 10% 7,725 = 9.7%
Return on total assets 75,000 80,000
(net income/total assets)
*During the year Firm B held Rs.5,000 in marketable securities, which earned a 9 percent return
or Rs.450 for the year. After paying taxes at a rate of 50 percent, the firm netted a Rs.225 return
on this investment.

59
Concepts and Determination Activity 4.1
of Working Capital
Give points of distinction between the Walker's Approach and Trade off
Approach.
..............................................................................................................................

..............................................................................................................................

..............................................................................................................................

..............................................................................................................................

..............................................................................................................................

4.4 APPROACH TO FINANCING WORKING

CAPITAL
Financing the firm’s working capital requirements has been shown to involve
simultaneous and inter-related decisions regarding the firm’s investment in current
assets. Fortunately, there exists a principle, which can be used as a guide to
firm’s working capital financing decisions. This is the hedging principle or
matching principle.

Simply speaking, the hedging principle involves matching the cash flow generating
characteristics of an asset with the maturity of the source of financing used to
finance its acquisition. For example, a seasonal expansion in inventories, according
to the hedging principle, should be financed with a short-term loan or current
liability. The rationale underlying the rule is straightforward. Funds are needed for
a limited period of time, and when that time has passed, the cash needed to
repay the loan will be generated by the sale of the extra inventory items.
Obtaining the needed funds from a long-term source (longer than one year)
would mean that the firm would still have the funds after the inventories (they
helped finance) have been sold. In this case the firm would have “excess”
liquidity, which they either hold in cash or invest in low yielding marketable
securities until the seasonal increase in inventories occurs again and the funds are
needed. This would result in an over-all lowering of firm profits, as we saw
earlier in the example presented in Table 4.2.

Let us take another example in which a firm purchases a new packing machine,
which is expected to produce cash saving to the firm by eliminating the need for
two labourers and, consequently their salaries. This amounts to an annual savings
of Rs.20,000. while the new machine costs Rs. 1,00,000 to install and will last 10
years. If the firm chooses to finance this asset with a one-year loan, then it will
not be able to repay the loan from the cash flow generated by the asset. Hence,
in accordance with the hedging principle, the firm should finance the asset with a
source of financing that more nearly matches the expected life and cash flow
generating characteristics of the asset. In this case a 7 to 10-year loan would be
more appropriate than a one-year loan.

To put it very succinctly the hedging principle states that the firm’s assets not
financed by spontaneous sources should be financed in accordance with the rule:
permanent assets (including permanent working capital needs) financed with long-
term sources and temporary assets (viz. fluctuating working capital need) with
short-term sources of finance towards the liquidity risk.

We may graphically illustrate the hedging principle as depicted in Figure 4.2A

60
 Figure: 4.2A : Hedging Financing strategy Theories and Approaches

Temporary Current Short Term

Assets Financing
Investment

Assets
Current
Per manent
Long Term
Financing
Fixed Assets

Note that permanent asset needs are matched exactly with spontaneous plus long-term sources of
financing while temporary current assets are financed with short-term sources of financing.

This may be termed as hedging financing strategy. In practice we may come

across certain modifications of this strict hedging strategy. Figure 4.2B and 4.2C
depict two modifications.
Figure: 4.2B
Conservative financing strategy: Long term financing exceeds permanent assets

12345678901234567890123456789012123456789012345678901234567890
12345678901234567890123456789012123456789012345678901234567890
Temporary CAS Short Term
12345678901234567890123456789012123456789012345678901234567890
12345678901234567890123456789012123456789012345678901234567890
12345678901234567890123456789012123456789012345678901234567890Financing
12345678901234567890123456789012123456789012345678901234567890
12345678901234567890123456789012123456789012345678901234567890
12345678901234567890123456789012123456789012345678901234567890
12345678901234567890123456789012123456789012345678901234567890
12345678901234567890123456789012123456789012345678901234567890
12345678901234567890123456789012123456789012345678901234567890
12345678901234567890123456789012123456789012345678901234567890
12345678901234567890123456789012123456789012345678901234567890
12345678901234567890123456789012123456789012345678901234567890
Investment

12345678901234567890123456789012123456789012345678901234567890
ssets
12345678901234567890123456789012123456789012345678901234567890
e n t C u rrent A
Perman
Long Term
Financing
Fixed Assets

Shaded area represents the firm’s use of long-term plus spontaneous financing in excess
of the firm’s permanent asset financing needs.

Figure: 4.2C : Aggressive Financing strategy: Permanent Reliance on Short Term Financing

Temporary CAS
1234567890123456789012345678901212345678901234567890123456789
1234567890123456789012345678901212345678901234567890123456789Short Terms
1234567890123456789012345678901212345678901234567890123456789
1234567890123456789012345678901212345678901234567890123456789
1234567890123456789012345678901212345678901234567890123456789
1234567890123456789012345678901212345678901234567890123456789
Financing
1234567890123456789012345678901212345678901234567890123456789
1234567890123456789012345678901212345678901234567890123456789
1234567890123456789012345678901212345678901234567890123456789
1234567890123456789012345678901212345678901234567890123456789
1234567890123456789012345678901212345678901234567890123456789
1234567890123456789012345678901212345678901234567890123456789
Investment

1234567890123456789012345678901212345678901234567890123456789
1234567890123456789012345678901212345678901234567890123456789
1234567890123456789012345678901212345678901234567890123456789
1234567890123456789012345678901212345678901234567890123456789
ts
C u r r e nt Asse
ent
Perman Long Terms
Financing
Fixed Assets

Shaded area reflects the firm’s continuous use of short-term financing to support its
permanent asset needs. 61
Concepts and Determination In Figure 4.2B the firm follows a more cautious plan, whereby long-term sources
of Working Capital of financing exceed permanent assets in trough period such that excess cash is
available (which must be invested in marketable securities). Note that the firm
actually has excess liquidity during the low ebb of its asset cycle and thus faces
a lower risk of being caught short of cash than a firm that follows the pure
hedging approach. However, the firm also increases its investment in relatively
low-yielding assets such that its return on investment is diminished (recall the
example from Table 1.2).

In contrast, Figure 4.2C depicts a firm that continually finances a part of its
permanent asset needs with short term funds and thus follows a more aggressive
strategy in managing its working capital. It can be seen that even when its
investment in asset needs is lowest the firm must still rely on short-term
financing. Such a firm would be subjected to increased risks of cash shortfall, in
that it must depend on a continual rollover or replacement of its short-term debt
with more short-term debt. The benefit derived from following such a policy
relates to the possible savings resulting from the use of lower-cost short-term
debt as opposed to long-term debt.

Most firms will not exclusively follow any one of the three strategies outlined
above in determining their reliance on short-term credit. Instead, a firm will at
times find itself overly reliant on long term financing and thus holding excess
cash and at other times it may have to rely on short-term financing throughout an
entire operating cycle. The hedging principle does, however; provide an important
guide regarding the appropriate use of short-term credit for working capital
financing.

4.5 EFFECT OF CHOICE OF FINANCING ON ROI

It would be now pertinent to examine the impact of the choice of financing on,
return on investment. Consider the following Data in Table-4.3
Table 4.3 : Effect of choice of financing on ROI

Balance Sheet Firm X Firm Y

Rs. Rs.
Current Assets 40,000 40,000
Fixed Assets 80,000 80,000
–––––––– ––––––––
Total Assets 1,20,000 1,20,000
–––––––– ––––––––
Accounts payable 10,000 10,000
Bank credit (10%) 0 30,000
–––––––– ––––––––
Current liabilities 10,000 40,000
–––––––– ––––––––
Long Term Debt (16%) 30,000 0
Equity 80,000 80,000
–––––––– ––––––––
Total Liabilities 1,20,000 1,20,000
–––––––– ––––––––

62
Income Statement Firm X Firm Y Theories and Approaches
Net operating Income (EBIT) 64,800 64,800
Less Interest 4,800 3,000
–––––––– ––––––––
Taxable Income 60,000 61,800
Taxes @ 50% 30,000 30,900
–––––––– ––––––––
PAT (Net Income) 30,000 30,900
–––––––– ––––––––
Measures of Liquidity
(a) Current Ratio 4:1 1:1
(b) Net working capital 30,000 0
Measures of profitability
(a) ROl 37.5% 38.6%
(b)EPS Rs 3.00 Rs 3.09
It is evident from the data contained in Table 4.3 that the Firm (X) using long
term debt has a current ratio of 4 times and Rs.30,000 in net working capital,
whereas Firm Y’s current ratio is only 1 time, which represents zero net working
capital. Because of lower interest rates on short-term debt (bank credit in this
case) Firm ‘Y’ was able to earn a ROI of 38.6 percent compared to that of ‘X’,
which could earn only 37.5 percent. Thus a firm can reduce its risk of illiquidity
through the use of long term debt at the expense of a reduction of its return on
investment funds. Once again we see that the risk-return trade-off involves an
increased risk of illiquidity versus increased profitability.

4.6 SUMMARY
It has been noted in this unit that value is created by virtue of investment in both
fixed and current assets. It is also found that the same criterion of selection of
projects used for fixed investment holds good for investments in working capital;
though the inter-related nature of current assets and current liabilities makes the
job of managing working capital difficult. To attain this objective function,
different approaches have been suggested. The early contribution of Walker is
found to be of immense use in this regard. The principles laid down by him need
to be tested in practice and deviations to be examined. It is further highlighted
that working capital decisions involve trade-off between risk and return. This
operates within the investment and financing areas. Different approaches have
been examined in this unit with suitable examples to highlight the impact of the
variables on the working capital decision-making. Against these theoretical
foundations, the students are expected to compare their practices and enrich the
existing knowledge base.

4.7 KEY WORDS

Aggressive financing Strategy: A portion of permanent assets financed with
short-term sources.
Considervative financing strategy : A portion of the temporary assets financed
with long term sources.
Hedging principle: The firm’s assets not financed by spontaneous sources
should be financed in accordance with the rule: permanent assets financed with
long-term sources and temporary assets with short-term sources.
63
Concepts and Determination Reversible investment: An investment, the cash flow related to which could
of Working Capital be readily reversed.

Spontaneous finance: Credit, which arises in direct conjunction with the day-to-
day operations of the firm.

Creation of value: The process of maximising the market price of the

company’s common stock. This occurs when the finance manager does
something that shareholder cannot do for themselves.

Net present value: The difference between the present value of inflows
generated by a project minus the initial investment made in that project.

4.8 SELF-ASSESSMENT QUESTIONS

1) Distinguish between Fixed asset management and current asset management.
2) How is value created through working capital management?
3) ‘Merely increasing the level of investment in current assets does not reduce
the working capital risks of a firm’ - comment.
4) ‘Working capital, like other financial management decisions involves risk-
return trade-off: yet the same is unique’. Elaborate with suitable examples.

5) Examine with suitable examples the principles of Walker.

6) Illustrate, using hypothetical data, the risks-return trade-off involved in current

asset investment and financing decisions.

7) Distinguish matching, conservative and aggressive working capital financing

strategies. Under the present capital and money market conditions, which of
these would you recommend to a consumer durable manufacturing firm?
Why? List out your assumptions, if any.

8) The balance sheet of the Cooptex Manufacturing Company is presented

below for the year ended December 31, 2003.

Cooptex Manufacturing Co.

Balance sheet as on Dec. 31, 2003

Current Liabilities Rs 30,000 Net Fixed Assets Rs 50,000
Long-Term Liabilities Rs 20,000 Current Assets:
Equity Capital Rs 50,000 Cash 5,000
Inventories 25,000
Accounts Receivable 20,000 Rs 50,000
––––––––– –––––– –––––––
1,00,000 1,00,000
––––––––– –––––––
During 2003 the firm earned net income after taxes of Rs. 10,000 based on net
sales of Rs.2,00,000.
a) Calculate Cooptex’s current ratio, net working capital and return on total
assets ratio (net income/total assets) using the above information.

b) The General Manager (Finance) of Cooptex is considering a Plan for

enhancing the firm’s liquidity. The plan involves raising Rs.l0,000 by issuing
equity shares and investing in marketable securities that will earn 10 percent
before taxes and 5 per cent after taxes. Calculate Cooptex’s current ratio,
64