Assessing the Impact of Market Returns on Expected Return: A Study of KMD

In this assignment, the concept of risk-free rate is discussed. It highlights that a decline in market return can lead to a decrease in expected return. The study also explores the importance of examining the financial position of a company before making investment decisions, taking into account risks such as leverage and liquidity risk.

Working capital management
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Table of Contents
INTRODUCTION................................................................................................................................3
TASK 1.................................................................................................................................................3
Working capital management..........................................................................................................3
TASK 2.................................................................................................................................................5
Risk and return.................................................................................................................................5
CONCLUSION....................................................................................................................................7
REFERENCES.....................................................................................................................................8
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INTRODUCTION
Every commercial establishment whether small or large size needs to assure sufficient amount
of funds to meet their daily operational need, called as working capital. It is important because
without having proper money, they cannot run their routine functioning such as buying material and
payment of salary, bills, accounts payable, rent, rates and taxes etc. The present report lay
emphasize on the different ways of managing working capital in Kathmandu Holding Ltd. (KMD).
Moreover, it will be analysed with its competitor, Oroton Group Ltd (ORL). Effective and efficient
management of WC is a sign of strengthen short-term ability of the company to pay timely to their
current liabilities.
TASK 1
Working capital management
Cash conversion cycle: CCC indicates the time period which KMD takes to convert its
resources into cash flows. In other words, it express the net time period between the total receipts of
cash funds from their debtors and inventory over the length of time, in which, company will make
its deferral payments to their payables (Sivashanmugam and Krishnakumar, 2016). It is mainly used
to analyse and examine the effectiveness of management to generate quickly the cash flows and
thereby ensure sufficient availability of WC.
CCC = Days inventory outstanding + days sales outstanding – days payable outstanding
DIO indicates the time period to sale the entire inventory into the market whereas DSO
express the length of time in which company receive its cash from the debtors (Deepa and et.al.,
2016). However, the time lag to pay the deferral payments to the suppliers for their supplies is
called as DPO.
Figure 1 Calculation of Cash conversion Cycle
Particulars KMD ORL
DIO 100.99 days 224.12 days
DSO 0.09 days 10.55 days
Total 101.08 days 234.67 days
DIO 39.27 days 72.23 days
CCC 61.81 days 162.44 days
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Interpretation: According to the table, it can be seen that KMD’s DIO is smaller than that of
ORL, which is good as it depicts that KMD’s management take less time to sale its entire inventory
to the customers (Kathmandu Holdings Ltd, 2016). It is surely the strength for the company due to
increasing market demand via advertisement and other promotional tools and techniques. Along
with this, better pricing policy also boosted sales and stock turnover, which in turn, reduces the
DIO. Moreover, KMD’s DSO is also very less to only 0.09 days than ORL’s ratio to 10.55 days
which shows that its managers are receiving quickly the cash flows from their debtors and accounts
receivables to enhance their cash position (Moghadam and Rahimi, 2016). It may be due to tighten
the terms of credit sales and provided incentives for getting faster payments from receivables such
as by offering cash discounts. However, KMD’s DPO is comparatively shorter to 39.27 whereas
ORL’s DPO is higher to 72.33 days (ORL Group Ltd, 2015). It is the weakness which demonstrates
that KMD’s managers are making prompt payments to their payables which decline their cash
availability and may bring hurdles in the effective management of WC. The CCC of KMD is 61.81
days that is smaller than ORL’s ratio of 162.44 days, which is a good sign of its WC management
strategy.
Recommendation
 In order to increase DPO, it can be recommended that KMD must stretch the credit terms
with the suppliers. Negotiating and bargaining with the creditors are the best ways available
to improve the DPO, which in turn, company will be able to remain cash for longer period
and meet their daily expenditures effectively (Das, 2016).
 DSO can be declined by regular communication with the customers to get earlier collection,
offering cash discounts on immediate payments, removing bad debtors and offering short-
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term credit facilities as well.
 Supply chain Finance is also considered as suitable way to improve WC efficiency (Working
capital management strategy, 2012). Further, effective management of market demand and
inventory optimization also helps to set maximum stock level and manage cash flow.
TASK 2
Risk and return
Table 1 Calculations of monthly return of KMD and S&P/ASX
(Prices in
AUD)
Date KMD
Monthly return -
KMD S&P/ASX - 200
Monthly return -
S&P/ASX-200
9/1/2016 1.90 3.26% 5239.90 -3.55%
8/1/2016 1.84 6.67% 5433.00 -2.32%
7/1/2016 1.73 17.75% 5562.30 6.28%
6/1/2016 1.47 2.99% 5233.40 -2.70%
5/2/2016 1.42 0.00% 5378.60 2.41%
4/1/2016 1.42 -3.01% 5252.20 3.33%
3/1/2016 1.47 6.03% 5082.80 4.14%
2/1/2016 1.38 2.17% 4880.90 -2.49%
1/1/2016 1.35 -6.25% 5005.50 -5.48%
12/1/2015 1.44 -0.88% 5295.90 2.50%
11/2/2015 1.46 3.14% 5166.50 -1.39%
10/1/2015 1.41 15.77% 5239.40 4.34%
9/1/2015 1.22 -16.67% 5021.60 -3.56%
8/3/2015 1.46 2.98% 5207.00 -8.64%
7/1/2015 1.42 -3.51% 5699.20 4.40%
6/1/2015 1.47 5459.00
Table 2 Calculations of capital gain
Initial price 1.47
Price at the ending of 12 months 1.90
Capital gain 0.43
Capital gain % 29%
Table 3 Calculations of average monthly return and standard deviation for KMD and market index
Average monthly return - KMD 2.03%
Average monthly return - S&P/ASX-200 -0.18%
Std. Deviation of monthly returns- KMD 8.30%
Std. Deviation of monthly returns- S&P/ASX -200 4.38%
Table 4 Calculation of beta value
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Beta value - KMD 0.77
In the portfolio strategy, diversification concept is of great significance which indicates that
an investor must invest their own money in two or more securities so that loss on one can be
adjusted against other. It is a risk management strategy that helps to minimize the investment risk
on entire portfolio (Berry, 2015). In the given scenario, monthly return for KMD and S&P/ASX are
2.03% and -0.18% whilst the standard deviation is 8.30% and 4.38% respectively. It demonstrates
that there is high investment risk in KMD, therefore, Aunty can use diversification technique,
through which, it can put its money into different securities by examining the potential risk and
return. With the assistance of this, it can minimizes risks and create an efficient portfolio to have
maximum return.
Systematic risk
This risk refers to the possibility of market volatility which can arise severe difficulties and
also can collapse the entire business of the KMD. The main reason for this risk is only the
fluctuations in external market which is outside the control of business, therefore, also called market
risk and un-diversifiable risk.
(Bromiley, P. and et.al., 2015)
Interest rate risk: If bank increase their lending rates than it will incline the cost of
borrowing for the KMD (Valipour, M. and et.al., 2015). Thus, the heavier the cost of debt results in
net profitability and decreases their operational performance.
Market risk: Risk of falling in stock price due to market risk like tough competition,
changing customer behaviour and many others are called market risk.
Unsystematic risk
This is also known as residual and specific risk, in which, KMD’s internal factors are
responsible for the risk occurred. It can be arise due to inefficient management of inventory, cash
position and sudden strike by the labour force etc.
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Liquidity risk: If KMD fails to manage proper availability of funds in the business to dispose-
off timely their short-term debts like payables than it is called liquidity risk (Bromiley, P. and et.al.,
2015).
Financial risk: It is also called credit risk, which mainly arises due to changing in the
composition of both the debt and equity capital. For instance, excessive debt impose legal
obligation to KMD to pay interest periodically whereas high use of equity capital can dilute the
business control to shareholders, therefore, both the situations can arise financial risk.
Fall in expected market return by 5%
Beta indicates the volatility in the market which measure risk due to fluctuations in
stock prices around the mean value.
Risk free rate (Rf) 2.11%
Beta 0.77
Market return (Rm) -0.18%
Expected return (Rf+ß *(Rm- Rf) 0.352%
Risk free rate (Rf) 2.11%
Beta 0.77
Market return (Rm) -5.18%
Expected return (Rf+ß *(Rm- Rf) -3.483%
Risk free rate has been extracted from trading economies. (Trading economics, 2016).
According to the table presented above, it can be seen that if market return fall by 5% than expected
return declines from 0.352% to -3.483%. It indicates an adverse change which depicts that if the
possibility of market returns declines than the expected return on the investment will be surely
decrease.
CONCLUSION
Above study concluded that KMD can maximize its net cash position by increasing their DPO
and declining their DSO and DIO. However, the second part of the report concluded that there is
different types of risk prevail in the business which can bring large fluctuations in the investors
return. Therefore, investors have to first examine the financial position of the company such as
leverage risk, liquidity risk and many others and thereafter take investment decisions to gain higher
return.
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REFERENCES
Books and Journals
Berry, C. H., 2015. Corporate growth and diversification. Princeton University Press.
Bromiley, P. and et.al., 2015. Enterprise risk management: Review, critique, and research
directions. Long range planning. 48(4). pp. 265-276.
Das, S., 2016. Impact of cash conversion cycle for measuring the efficiency of cash management: A
study on pharmaceutical sector. Accounting. 2(4). pp. 143-150.
Deepa, N. and et.al., 2016. Influence of Cash Conversion Cycle on Financial Performance of
Coconut Oil Mills in Western Tamil Nadu. Indian Journal of Economics and Development.
12(1). pp. 143-150.
Moghadam, A. and Rahimi, M., 2016. The Relationship between Working Capital Management and
Cash Flows on the Financial Performance of Manufacturing Firms. Asian Journal of
Research in Banking and Finance. 6(6). pp. 34-42.
Sivashanmugam, C. and Krishnakumar, S., 2016. Working Capital Management and Corporate
Profitability: Empirical Evidences from Indian Cement Companies. Asian Journal of
Research in Social Sciences and Humanities. 6(7). pp. 1471-1486.
Valipour, M. and et.al., 2015. Forecasting stock systematic risk using Heuristic Algorithms. Journal
of productivity and development. 1(1). pp. 36-41.
Online
Kathmandu Holdings Ltd. 2016. [PDF]. Available
through<:http://192.168.1.18/projectfiles/internal_cust_document/201609141957240651473
854794_147354901.pdf>. [Accessed on 16th September 2016].
ORL Group Ltd. 2015. [Online]. Available through: <
http://financials.morningstar.com/ratios/r.html?t=ORL>. [Accessed on 16th September
2016].
Trading economics. 2016. [Online]. Available through:
http://www.tradingeconomics.com/australia/government-bond-yieldRegards. [Accessed on
16th September 2016].
Working capital management strategy. 2012. [Online]. Available through: < http://www.strategy-at-
risk.com/2012/11/27/working-capital-strategy-revisited/>. [Accessed on 16th September
2016].
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