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Epgp (one year) 2009-10_cf_ assignment_#4_19jan10
Epgp (one year) 2009-10_cf_ assignment_#4_19jan10
Epgp (one year) 2009-10_cf_ assignment_#4_19jan10
Epgp (one year) 2009-10_cf_ assignment_#4_19jan10
Epgp (one year) 2009-10_cf_ assignment_#4_19jan10
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Epgp (one year) 2009-10_cf_ assignment_#4_19jan10


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  • 1. Corporate Finance Assignment #4 – Dell’s Working Capital EPGP 2009-10 - Term III- Individual Submission 20-Jan-2009 Instructor: Prof. A. Kanagaraj Submitted by: Rajendra Inani - #27 CF –Individual Assignment#4 Page |1
  • 2. Table of Contents 2 1 Dell’s Working Capital .......................................................................................................................3 2 Competitive Advantage......................................................................................................................3 3 How Dell funded its fiscal 1996 sales growth ....................................................................................3 4 Dell’s internal funding options for projected sales growth of 50% in fiscal 1997 ..............................5 CF –Individual Assignment#4 Page |2
  • 3. 1 Dell’s Working Capital Dell manufactures, sells, and services personal computers. The company markets directly to its customers and builds computers after receiving a customer order. This build-to-order model enables Dell to have much smaller investments in working capital than its competitors. It also enables Dell to enjoy more fully the benefits of reductions in component prices and to introduce new products more rapidly. Dell has grown quickly and has been able to finance that growth internally by its efficient use of working capital and its profitability. 2 Competitive Advantage The extent of Dell’s working capital advantage over its competitors can be assessed using data contained in Table A of the case on days sales of inventory (DSI) for Dell and its competitors. In 1994 and 1995, Dell’s DSI was about half the level of its competitors. In January 1996, for example, Dell had inventory to cover 32 days of sales while Compaq Computer had inventory to cover 73 days of sales. One way for students to quantify Dell’s competitive advantage is to calculate the increase in inventory Dell would have needed if it operated at Compaq’s DSI level. Using Dell’s cost of sales (COS) for 1995 contained in Exhibit 4 and the information on DSI contained in Table A: Additional inventory at Compaq’s DSI = ( Dell’s COS) (Compaq’s DSI – Dell’s DSI)/360 days = [($2,737) (73-32)]/360 = $312 million. This $312 million, in perspective, represents 59% of Dell’s cash and short term investments, 48% of stockholder equity and 209% of its 1996 income. 3 How Dell funded its fiscal 1996 sales growth In order to determine how Dell funded its fiscal 1996 sales growth, we must first analyze how much fund Dell exactly needed to sustain such 52% growth in 1996. Operating Assets = Total Assets – short term investment = $1594 - $484 = $1110 The Operating assets in proportion to sales = $1110/$3475 = 32% Sales increased from $3457 in 1995 to $5296 in 1996. From our previous calculations, we have found that operating assets are a proportion of sales and would therefore equal 32%. In order to figure out the required amount of increase in operating assets as a result of an increase in sales, we should multiply the increase in sales by 32%. Therefore, 0.32 x (5296-3457) = $582 million, which would be the total operating assets that Dell would need to fund in order to sustain the 52% growth in sales. Liabilities in proportion to sales in 1995 = $942/$3475 = 27.1%, Increase in liabilities in 1996 = (5296-3475) x 0.271 = $494 Therefore, Dell would have the increase of 582 million in operating assets, there would also be a 494 million increase in liabilities. Short Term investments would remain the same, since it is not directly related to operations. Net Profit / Sales = $149/$3475 = 4.3%, Operational profits = 5296*4.3% = $ 227 million CF –Individual Assignment#4 Page |3
  • 4. In all, we have calculated that with the sales increase of 52% there will be $582 million operating assets that Dell should fund. The 52% sales increase would also bring additional $494 million in liabilities, while generating 227 million of operating profit yet the short term investment would remain unchanged at $484 million. As a result, any two combination of liabilities, operational profit, or short term investment will be sufficient to offset the %582 million operating assets needed to sustain the 52% sales growth in 1996. Based on previous calculations, we find that in order for Dell to finance its 52% growth, the firm will require 582 million in terms of increase in operating assets. Nevertheless, this number can be further reduced if the company undergoes internal process improvement, which would result in higher asset efficiently. For 1995, the operating assets in terms of % of sales can be calculated once again by subtracting short term investment from total assets, and the number comes out to be around 31.94%. Likewise in 1996, the operating assets = 2148-591 = 29.4% Difference of the year 1995 and 1996, 31.94 – 29.4 = 2.54% There is decrease in operating assets by 2.54% in year 1996, operation efficiency has improved by this amount. Thus, decrease in operating asset in 1996 = 5296 x 2.54% = 134.5 million This amount can be further reduced from the original forecast $582 million required for 52% growth in 1996. The higher asset efficiency can be achieved through reducing company’s current asset, which includes cash available, account receivables, inventory, or other current assets. Thus, actual additional operating asset needed to fund the 52% increase in sales = 582 – 134.5 = $447.5 million To put everything in perspective, we need to compare both sides of the balance sheet to determine if additional fund is needed. In other words, the sum of current liabilities, long term debt and retained earnings needs to exceed the sum of current assets and fixed assets for Dell to avoid raising public fund such as issuing more stocks. Based on the numbers provided by Ex4 and Ex5 of the case, we find that the retained earnings (Net Profit) come out to be $272 million, and there is no difference in long term debt. The $272 million in net profit is an increase from the forecasted $227 million and can be attributed to improved net margins from 4.3% to 5.1%. Also, we can calculated that the increase in current liabilities = $939 - $752 = $187 million. Based on the balance sheet, we find that total liability together with a higher than anticipated net profit is larger than the additional operating asset requirement calculated, $272 + $187 = $459 million > $447.5 million. Therefore, without relying on external alternatives, Dell was able to fund its 1996 sales growth through internal resources, i.e. reducing its current assets and increasing its net margin. CF –Individual Assignment#4 Page |4
  • 5. 4 Dell’s internal funding options for projected sales growth of 50% in fiscal 1997 Operating assets as a % of sales for 1996 = Total assets – Short Term Investments = $2148 - $591 = $1557 million Percentage of Net profit as a % of sales for 1996 = Net Profit / Sales = $272/$5296 = 5.1% of Sales When sales increase by 50%, we must also assume that operating assets will also be increased by the same amount. Hence for 1997, Dell requires $1557 x 1.5 = $2336 million of worth of operating assets. Thus, an increase in sales of 50%, the increase in operating assets from 1996 – 1997 would amount to $2336 - $1557 = $779 million. The liabilities and net profit as a percentage of sales will also be increased proportionally by 50% for 1997. Thus, % of Net Profit (1996) x Sales (1996) x 1.5 = 5.1% x %5296 x 1.5 = $405 million. Total liabilities as a % of sales would equal Liabilities (1996) x 50% = $1175 x 0.5 = $588 million. Considering that short term investments will be around $591 million in average for 1997, we have a total of $405 + $588 + $591 = $1584 million which is well above the required increase of sales in operating assets ($799 million). Therefore, with the increase in liabilities, projected net profit for 1997, and current short term investment, Dell will have enough money for internal funding. Dell may choose any way to allocate these funds. For instance: 1. If their short term investments have shown phenomenal growth, they may decide to realize these gains and sell off all of these investments, which would then cover most of the required operating assets. 2. If the cost of new debt is high, they may choose not to increase their liabilities and instead fund the growth with short term investments and their net profits. 3. Alternatively as an option for internal funding, Dell could sell its fixed assets, or reduce inventory, accounts receivables, and increase payables. The latter brings up the idea of working capital improvements. If we look at Dell’s operations and their use of JIT, it is highly plausible for them to achieve a negative Cash Conversion Cycle. If they receive terms from their suppliers of 30-45 days while also using JIT to receive immediate payment from customers, it is possible to improve working capital from the previous year by reducing inventory and receivables. Furthermore, with their size and influence, they can demand increased payment terms and limits, thus increasing accounts payable period. This all combines to the possibility of a negative Cash Cycle and the ability to fuel the company’s growth. Finally, we see that Dell has the potential to utilize $1584 million towards their internal growth. This amount is easily able to cover the required forecasted amount of operating assets of $779 million. With the reminder of the funds, it is possible for Dell to utilize it to pay off long term debt or to buy back common stock thus increasing EPS. CF –Individual Assignment#4 Page |5