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Working Capital and Return on Investment

III- Working Capital Management
A- Applegate Bicycle Company is trying to devise an aprópiate working capital policy. Their most recent balance sheet is as follows: Balance Sheet, December 31, 20X5 (in thousands)
Assets Liabilities and Owner's Equity
Cash $ 30 Accounts payable $35
Accounts Receivable 50 Notes payable 10
Inventories 30 Accruals 5
Current Assets $110 Current Liabilities $50
Net fixed assets 150 Mortgage loan (at 13%) 80
Common equity 130
Total liabilities and
Total assets $260 owner's equity $260

You know that net profits in 20X5 were $28,000.

1- What is Applegate's current level of working capital?

2- What percentage of total assets is invested in working capital?

3- Calculate Applegate's return on investment (ROI).

4- Suppose the firm reduces cash, accounts receivable, and inventory by 10% and uses the proceeds to pay off some of its accounts payable. Now, assuming all other items remain the same, answer a, b, and c above using these new figures. What has happened? What warning would you offer?

Solution Preview

1- Applegate's current level of working capital is the excess of its current assets ($110) over its current liabilities ($60), or $50.

2- Of Applegate's total assets of $260, $110 is invested in current assets. Therefore, $110/$260=.4231, or 42.31 percent.

3- Applegate's return on investment is its net profits divided by its total assets. Therefore, $28/$260=.1077 or 10.77 ...

Solution Summary

This solution addresses the computation of working capital, the computation of current assets as a percentage of total assets, and the effect of a change in working capital on return on investment.