ExpertACCA · Question 32 · Working Capital Management
Section C
EcoTransit is a public utility hybrid transitioning from government grants to commercial debt. It provides electric bus networks. The company has experienced rapid revenue growth over the last two years but is facing severe liquidity issues.
Financial data for the last two years:
Year 20X1 ($m) Year 20X2 ($m) Revenue 45.0 75.0 Cost of Sales 30.0 55.0 Inventory 4.5 11.0 Receivables 6.0 15.0 Payables 5.0 14.0 Overdraft 1.0 8.5
Assume a 365-day year.
EcoTransit is also planning a new commercial venture into electric ferry services. The current WACC of EcoTransit is 9%. However, the electric ferry industry has a different risk profile. A proxy company operating exclusively in electric ferries has an equity beta of 1.5 and a debt-to-equity ratio of 1:2 by market value.
EcoTransit plans to finance the new ferry venture with a debt-to-equity ratio of 1:4. The risk-free rate is 3%, the market risk premium is 6%, and the pre-tax cost of debt for EcoTransit will be 5%. The corporate tax rate is 20%.
Required:
(a) Calculate the working capital ratios (Inventory days, Receivables days, Payables days, and Current Ratio) for both 20X1 and 20X2. (6 marks)
(b) Based on your calculations in part (a) and the financial data provided, evaluate whether EcoTransit is exhibiting symptoms of 'overtrading' (undercapitalization). (6 marks)
(c) Calculate the project-specific Weighted Average Cost of Capital (WACC) that EcoTransit should use to appraise the new electric ferry venture. (8 marks)
Section C
EcoTransit is a public utility hybrid transitioning from government grants to commercial debt. It provides electric bus networks. The company has experienced rapid revenue growth over the last two years but is facing severe liquidity issues.
Financial data for the last two years:
| Year 20X1 ($m) | Year 20X2 ($m) | |
|---|---|---|
| Revenue | 45.0 | 75.0 |
| Cost of Sales | 30.0 | 55.0 |
| Inventory | 4.5 | 11.0 |
| Receivables | 6.0 | 15.0 |
| Payables | 5.0 | 14.0 |
| Overdraft | 1.0 | 8.5 |
Assume a 365-day year.
EcoTransit is also planning a new commercial venture into electric ferry services. The current WACC of EcoTransit is 9%. However, the electric ferry industry has a different risk profile. A proxy company operating exclusively in electric ferries has an equity beta of 1.5 and a debt-to-equity ratio of 1:2 by market value.
EcoTransit plans to finance the new ferry venture with a debt-to-equity ratio of 1:4. The risk-free rate is 3%, the market risk premium is 6%, and the pre-tax cost of debt for EcoTransit will be 5%. The corporate tax rate is 20%.
Required:
(a) Calculate the working capital ratios (Inventory days, Receivables days, Payables days, and Current Ratio) for both 20X1 and 20X2. (6 marks)
(b) Based on your calculations in part (a) and the financial data provided, evaluate whether EcoTransit is exhibiting symptoms of 'overtrading' (undercapitalization). (6 marks)
(c) Calculate the project-specific Weighted Average Cost of Capital (WACC) that EcoTransit should use to appraise the new electric ferry venture. (8 marks)
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