Question

Firm value based approach- illustration

Current year Revenue: INR 500 crores

Earnings before Interest and after Tax (EBIAT) or Net Operating Profit after Tax (NOPAT): 10%

Present investment in WC: zero

Present Growth rate in operating income: 5%

Current cost of capital: 15%

Cost of Capital drops by 0.10% for every 10% increase in WC/Revenue

Growth rate in revenue and EBIAT: 6%,6.5% ,6.83% and 6.93% when WC/Rev is 10%,20% , 30% and 40% respectively.

Ignore delta capex depreciation and amortization. What is the optical WC/Rev % (0%,10%,20%,30%,40%) calculations required for all

Answer 1

Sl.No	WC	0%	10%	20%	30%	40%
i	Cost of capital (Current cost of capital-[0.01*WC])	15%	14.90%	14.80%	14.70%	14.60%
ii	EBIAT (Revenue*10%)	50	50	50	50	50
iii	Growth rate in EBIAT (Given)	5%	6%	6.50%	6.83%	6.93%
iv	Expected EBIAT (ii*[1+iii])	52.5	53	53.25	53.415	53.465
v	cost of capital - growth rate (i-iii)	10%	8.90%	8.30%	7.87%	7.67%
vi	Firm value (iv/v)	525.00	595.51	641.57	678.72	697.07

WC 40% is optimal, because at this level Firm value is maximum.