Working Capital Management and Cost of Capital - Essay Example

Working Capital Management and Cost of Capital By Task Cost of capital is such a terminology that rests under the field of financial assistance for the business. The cost of capital can be performed in dual scenario for instance it can be termed as cost of equity where business is merely financed all the way through equity. On the other hand, it reacts as a financing debt if the business is financing their operations through debt (Dayanada, 2002, pp. 21-25). However, there are a number of organizations that believe to exploit both methods of capital of capital in order to make a financial investment for their businesses. Therefore, for those organizations, the cost of capital can be measured through a weighted average method that can be termed as weighted average cost capital. In specific, the execution of cost of capital is due to figure out the hurdle rate that the companies come across with and are supposed to overcome in order to generate earnings. This method is widely exploited during the process of capital budgeting to identify the risk or favorable scenario for the company to proceed with a concerned project (Droms and Wright, 2010, pp. 31-34). From the financer’s standpoint, the investors are looking for respective profit over the company’s existing securities portfolio, which is used to assess a companys new project, because it is expected return that the investor is anticipated for providing funds, with the lowest rate of return, thereby establishing a benchmark that should be adhered by the new project (Pedell, 2006, pp. 26-31). The main perspective of this assignment is to analyze the cost of capital, which often known as Weighted Average Cost of Capital (WACC) of the chosen organization. The company that has been chosen for the same analysis is Tesco Plc. Tesco Plc is a British based multinational grocery and general merchandise retailer with its headquartering located in England, United Kingdom (UK). Tesco Plc is known as the second largest retailer in the world after the Wall-Mart. The company earned net revenue amounting to £70.894 billion in the year 2013 with net income amounting to £124.0 million in the same year. Explanation and Justification of the Method Used The method which has been used for computing the WACC of the selected company comprises on two different aspects, which are cost of debt and cost of equity. The formula of WACC institutionalized to cumulate cost of debt and cost of equity by applying relevant amount of weights with these elements. The justification of this particular method lies in the fact that this method has the tendency to analyze the cost of capital of the companies in particular. We have analyzed the weight age with the help of Debt to Equity Ratio of the company, from which we have analyzed that how much weight of debt is there in the company and how much of equity are there. This particular method of computing WACC is the best available method which could be used by the companies for the same purpose. Cost of Capital Computation There are two important things that count under analyzing the cost of capital of a company that particularly are cost of debt and cost of equity. We have all the information to analyze the cost of equity of the company, and we are using the Capital Asset Pricing Model for the same analysis. CAPM = RRF + Beta (RM – RRF) RM – RRF = Risk Premium = 5% CAPM = 4.13% + 0.286 * (5) = 4.13 + 1.43 CAPM = 5.56% COST OF EQUITY = 5.56% Now, we have to analyze the after tax cost of debt of the company in order to reach to a certain conclusion. From the discounted cash flow of the company is 8.8% before tax. The tax rate of the company is 26%. Let’s now examine the after tax cost of debt of the company = 8.8 * (1-26%) Cost of Debt = 6.512% Let’s now examine the Cost of Capital (COC) or WACC of the company in particular, but it is essential to analyze the Capital Structure of the company Total Debt = 33,468 Million Total Equity = 16,661 million Debt to Equity = 2.00 Debt to Equity / (1+Debt to Equity) = 2.00 / 3 Capital Structure (DEBT) = 66.6% Weight of (EQUITY) = 33.3% Cost of Capital would be COC = Weight of Debt * Cost of Debt + Weight of Equity * Cost of Equity = 66.6% * 6.512% + 33.3% * 5.56% = 4.29 + 1.851 Cost of Capital = 6.14% Remarks: The cost of Capital of Tesco Plc is 6.14% Task-2 There are certain aspects that deem important and effective for the sake of an organization and among them, the name of managing effectiveness is one of them ((Baker and Powell, 2005). There is a direct linkage found between productivity and management, as when managing the things in an organization in an effective manner, then it would be effective for them in the future (Baker and Powell, 2009). Finance is a broad field, and it has numerous concepts that needed to be covered accordingly and effectively at the same time. Theoretically, finance is the name of utilizing the funds of the company at a place from where in the likelihood of earning would be on a higher scale in particular. There are certain aspects that are considered as important for the organization’s existence, and it is equally beneficial from the viewpoint of financially based productivity (Armitage, 2005, pp. 12-17). Among numerous concepts of finance, the name of Working Capital is one of them. Apart from managing sales turnover and inventory, there are some other aspects as well that deem important and effective from the viewpoint of an organization from different angles and it is extremely vital for an organization to stay in the business in the same manner for their future belongings. Strategies lies in the heart of an organization and no organization could be in the net of economic prosperity and expansion without having effectiveness in their strategies. There are number of aspects that deem important for the sake of an organization and among them, the name of working capital management is one of them (Bhattacharyya, 2004). Managing the working capital is all about maintaining the current assets of the company higher than its current liabilities merely to finance their day to day operations in particular. The higher the management, the higher will be the chance associated with the companies to stay in the business for a long span of time (Bhattacharyya, 2004). Working capital management has now become an integral thing from the viewpoint of an organization. The main perspective of this particular part of the assignment is to analyze the effectiveness of working capital management and its relevance and its linkage with the value of the firm. We have mentioned many times that the stance of working capital is extremely important and effective from the viewpoint of an organization in particular. Many companies throughout the world are now focusing to maintain effectiveness in their organizations in particular. Obviously, every organization has a single thing in their mind which is to increase the financial belongings of the company accordingly and effectively and it is happened with the help of effective strategies in particular. Management the working capital is not an easy asks for the organization, as it requires tremendous amount of analysis and research in order to conduct the things in an effective and well organized manner. Working Capital Management and its Effectiveness A measure of both a company’s core efficiency and short and its short term financial health could be done with the help of working capital in particular and working capital ratios are the one that deem important for the sake of an organization (Bhattacharyya, 2004). Basically, working capital ratio indicates whether a company has enough cash from which they can pay their short term financial obligations accordingly and effectively. Usually Current ratio is the one that comes under the ambit of Working capital Management (Grosch, 2009). There are number of companies in the world which are now trying to have a positive attitude towards the working capital management and always try to give an upper hand to this particular element as far as increasing their economic prosperity is concerned (Hirschey, John and Makhija, 2009). Working capital management has its recognition for the companies from different standpoints and it is equally beneficial for the shareholders of the companies. Shareholders would get great apprehension with the help of effective Working Capital Management (WCM). Shareholders are the most important people from the standpoint of a company as they are the one who possess the highest amount of risk with an organization. Every organization thrives hard for increasing the shareholder’s wealth from different slants (Hirschey, John and Makhija, 2009). Shareholders always concerned with the economic prosperity of an organization and working capital is an important element through which a shareholder can have impulsive effectiveness. The shareholders would get apprehension in their effectiveness from the companies which are effective as far as managing the working capital is concerned. Lots of organizations of the world are now taking the advantage of managing working capital with effectiveness and among them, the name of different companies are some of them, which are registered on the different Stock Market in particular (McGuigan, Kretlow, Moyer and McGuigan, 2008). There are number of organizations in the world which are actually trying to influence and utilize the working capital management merely to enhance their productivity and strengthen their operations accordingly and effectively at the same time. Working capital usually have numerous aspects which could have been computed with the help of working capital management ratios and some of the major ratios are Current Ratio, Quick Ratio, Working Capital Ratio and short term working capital management ratios of the companies. It is required to analyze that is there any evidence found among the management of the working capital and its effectiveness with the organizations. This particular argument is extremely right because a company which has a edge and upper hand on the management of their working capital are effective and more organized as compared to those companies which don’t have any upper hand on the management of the working capital. Working Capital which is the difference among the current assets and current liabilities is an important stance from the viewpoint of a company. An organization which manages their working capital accordingly and effectively at the same time is more productive, because they have high chance of maintaining their operations and investment. Investment is an important aspect from the viewpoint of an organization and effective working capital management is the one which enables organizations to manage their operations and working capital in an effective and well organized manner. A firm’s value usually comprises on different things which is the difference among the assets and liabilities of a company, along with its investment stance and amount of total assets in particular. Working Capital Management certainly helps an organization to keep the operations of a going concern effective and perfect with the help of working capital management strategies and ratios. The ratios like Current Ratio and Quick Ratio are the one which tends to analyze the stance of a company as far as meeting with its short term financial promises. A company which has a Current and Quick Ratio higher than 1, is the one that found that the company always meet with its short term financial obligations and promises which is an effective sign from the viewpoint of the company. Apart from that, effective working capital management has a direct linkage with the profitability of the company as it gives a chance to the company to manage their operations in an effective and organized manner. Conclusion The main theme of this particular part is to analyze the effectiveness of working capital management and its effectiveness for the companies all over the world, with special emphasize on the value of the firm (McInnes, 2000). All of the public listed companies have to maintain effectiveness in their current management for their long and short term financial promises (Preve and Sarria-Allende, 2010). From this particular research paper, it is found that organizations throughout the world as well have to give immense recognition to the working capital management as it is an effective thing from their long term perspective especially to their shareholders to have a firm confidence over the companies for investment purpose. This particular aspect is quite important for the sake of an organization. References Armitage, S. (2005). The cost of capital. 1st ed. New York: Cambridge University Press. Dayanada, D. (2002). Capital budgeting. 1st ed. 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