Estimation of Working Capital 277The value of the firm = PV of free cash flows during the first five years + PV of terminal value of free
cash flows, the discount rate being 12 percent.
Value of equity = value of firm – value of debt outstanding
Value of a share = (value of equity/number of shares outstanding)Assume that working capital investment increases to 20 percent, cash flows will be reduced to that extent
and stock price will fall.
DETERMINANTS OF LEVEL OF WORKING CAPITAL
Bankers provide finance for holding an acceptable level of current assets for achieving a pre-determined
level of production and sales. So, each of the components of working capital needs to be estimated to quantify
the funds required for working capital.
Raw Materials
A company has to necessarily stock a minimum quality of raw materials to ensure smooth running of oper-
ations. The factors that should be considered while estimating the required inventory of raw material are:
- Average consumption of raw materials,
- Availability of raw materials,
- Lead time between ordering and receipt of materials,
- Cost of holding stocks,
- Transportation charges, and
- Seasonality of the item in question.
Work-in-Progress
Generally there is a time lag, only after which raw materials get converted into finished product. The time
taken for processing varies from industry to industry. The factors affecting the inventory of WIP are:
- Processing time,
- Batch quantity—the average quantity of each product processed, and
- Number of shifts in a day and plant capacity.
Finished Goods
Normally a certain quantity of finished goods may have to be held in inventory awaiting sale. The quantity
to be stored depends on:
- Variation in demand,
- Transportation delay,