What is working capital ? What are the factors that aretaken into account in determining capital needs of thefirm ?b) Explain how a suitable mix of short-term and long-termfinance can be used for financing current assets. 7 + 88. a) Cosco Industries have a policy of maintainingRs. 5,00,000 minimum cash balance. The standarddeviation of the company’s daily cash flow isRs. 2,00,000. The interest rate is 14%. The companyhas to spend Rs. 150 per transaction. Calculate theupper and lower limits and the return point as perMiller-Orr Model.b) A firm’s annual cash requirement is Rs. 2,00,00,000.The opportunity cost of capital is 15% per annum.Rs. 150 is the per transaction cost for the firm when itconverts its short-term securities to cash. Find out theoptimum cash balance. What is the annual cost of thedemand for the optimum cash balance ? 7 + 8

a) Working capital refers to the difference between a company's current assets and current liabilities. It is a measure of a company's operational efficiency and short-term financial health. If a company has positive working capital, it has enough assets to cover its short-term debts.

The factors taken into account in determining the capital needs of a firm include:

1. Nature of Business: A manufacturing company requires more capital compared to a service-based company.
2. Size of Business: Larger businesses require more capital than smaller ones.
3. Business Cycle: During a boom period, more working capital is required.
4. Production Cycle: A longer production cycle requires more working capital.
5. Credit Terms: If a company offers credit to its customers, it needs more working capital.

b) A suitable mix of short-term and long-term finance can be used for financing current assets by maintaining a balance between risk and profitability. Short-term finance is less expensive but riskier as it needs to be repaid within a short period. Long-term finance is more expensive but less risky. The mix can be determined based on the nature of the current assets. For example, for liquid assets, short-term finance can be used, while for less liquid assets, long-term finance can be more suitable.

8. a) The Miller-Orr Model is a model of cash management that suggests that firms should hold cash balances as a precaution against uncertainty. The upper limit, lower limit, and return point can be calculated as follows:

• Lower Limit = Minimum cash balance = Rs. 5,00,000
• Return Point = Lower Limit + (3 x Standard Deviation^2 x Transaction Cost / Interest Rate)^1/3
• Upper Limit = Lower Limit + 3*(Return Point - Lower Limit)

b) The optimum cash balance can be calculated using the Baumol's Model formula:

Optimum Cash Balance = √(2 x Annual Cash Requirement x Transaction Cost / Opportunity Cost of Capital)

The annual cost of the demand for the optimum cash balance can be calculated by multiplying the optimum cash balance by the opportunity cost of capital.