Risk-Return Relationship: Capital Management and Return on Investment - Essay Sample

I have taken an article that discusses the relationship between working capital management and return on investment. In working capital, management risk means possibility of obtaining unexpected return. High level of risk is associated with high return while low risk are associate to low return CITATION Mat15 \l 1033 (Mathuva, 2015). In working capital management risk return-relationship, help the company to know which investment decision. The management will invest on the project that will give the highest return at the lowest risk. The main objective of the organization is to make profit and hence as investor he will invest on the project that hill give the maximum return and within shortest time possible.

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Relationship between working capital management and short-term returns

In business, working capital is used as a benchmark to measure the ability of the company short-term obligations. It is obtained by subtracting the current liabilities from current assets. The current asset includes those assets that can be converted into cash with a period of not more than one year. The working capital management ensures that the company is able to meet its current obligation when they fall due. Through the effective capital management, the business is able to focus it short revenue on catering for the current liabilities. When the current assets are more than current liabilities, the company has a positive working capital and hence the company has the possibility of meeting all its need in foreseen future CITATION Sha15 \l 1033 (Shampa, 2015). The type of asset that the an investor chooses help to predict the future cashflow of the company. Working capital management help the investor to purchase fast moving inventories which gives returns within short time so as to meet the short current liabilities when they fall due CITATION Sha15 \l 1033 (Shampa, 2015).

The working capital management plays a critical role in the investment decision of any investor. The investor will use the concept of working capital to decide on what project that they will invest. The working management concept helps the managers to invest on produce the highest return at the lowest cost or risk CITATION Dam16 \l 1033 (Damodaran, 2016).

Economic/ Intrinsic value

The intrinsic value of asset refers to the fair value of the asset. It is the value, which the investors perceive toward certain company or stock intrinsic values is different to market value and book value of asset. Book value is asset value in the balance sheet that mean the net asset less intangible asset while market is the price of asset in the market if it was to be sold today. A factor to consider when determining the economic value of an asset includes the value of underlying asset an increase in the value of underlying asset increase the value of the company. The dividend rate at which the company pays its shareholder, the companies that pay high dividend rate are perceived to have high value and hence every investor will believe since the company is paying a high dividend rate then it is performing well in the market and hence increasing its value CITATION McN15 \l 1033 (McNeil & Embrechts, 2015). The other factor that determines the value of the asset is the expected cash flow in future. The assets, which are expected to yield more cash flow in future, have a high economic value.

The important of economic value to business leader

The business leaders and investors use the economic value to know whether the asset is undervalued or overvalued. The investor assess whether they will get the value for their money if they invest in the assets of the company, business leader can also use the economic value of an asset which they intend to sell. It is also an important concept in mergers and acquisition. When lending the money to a business the bank will be interested in knowing the economic value of the company through looking at their expected cash flow in future CITATION Alm14 \l 1033 (Almazari, 2014).

Reference

BIBLIOGRAPHY \l 1033 Almazari, A. A. (2014). Impact of internal factors on bank profitability: Comparative study between Saudi Arabia and Jordan. Journal of Applied Finance and banking, 4(1), 125.

Damodaran, A. (2016). Damodaran on valuation: security analysis for investment and corporate finance (Vol. 324). . John Wiley & Sons.

Mathuva, D. (2015). The Influence of working capital management components on corporate profitability.

McNeil, A. J., & Embrechts, P. (2015). Quantitative risk management: Concepts, techniques and tools. Princeton university press.

Shampa, F. R. (2015). Assessing Relationship between Working Capital Management and Return on Equity of Islamic Bank Bangladesh Limited.