Asset & Capital Management: Working capital, financing policy, debt vs equity financing

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See attached Excel file.

1. What are two problems that may be caused by too much working capital, and what are two problems that may be caused by too little working capital?

Gross working capital is the amount invested in current assets. Net Working capital is the difference between current assets and current liabilities. It is necessary to maintain the optimum working capital i.e., neither excess nor deficit working capital.

Problems caused by excess working capital:

1. The first problem of excessive working capital that is the company is losing the interest on the excess money as the company would have earned if it had invested the excess working capital in other investments. For example, the right amount of working capital is $100000 and the present working capital being $140000. Presently, the company is earning interest of 6% in its short term investments. If the company has invested $40000 being excess working capital ($140000-$100000), then it would have earned the interest of $2400. By simply holding excess cash, the company has lost $2400 interest per annum.

2. Excess working capital may result in overall inefficiency in the organization.

Problems caused by too little working capital:

1. If the company has little working capital i.e., lesser than the right amount of working capital it is difficult for the company to repay its debts when due. This will result in loss of reputation to the company and also the company will be charged by the creditors for the non -payment on the due dates. This is the additional financial costs on the company.

2. Rate of return on investments will also fall because of the insufficient working capital.

3. What are the relative advantages and disadvantages of a conservative asset financing policy and an aggressive asset financing policy?

Aggressive asset financing policy utilizes higher amount of current liabilities and less amount of long term debt. In aggressive financing policy the company uses short term less expensive funds. Advantages of aggressive financing policies are 1. Cost of funds is less as short term funds carry less interest rate than the long term funds. 2. It will increase the overall profitability of the company. The disadvantage of aggressive financing policy is that the company has to repay the short term funds at a short span of time. There may be the possibility of company running short of cash to repay the short term debt.

Conservative financing policy uses more long term debt and capital and less current liabilities. The ...