Ch026(1).doc

Chapter 26: Short-Term Finance and Planning 26.1 Start with the basic balance sheet equation, and substitute known definitions: Assets = Liabilities + Equity Current Assets + Fixed Assets = Current Liabilities + Long-Term Debt + Equity Since Net Working Capital = Current Assets - Current Liabilities, subtract Current Liabilities from both sides and substitute NWC: Net Working Capital + Fixed Assets = Long-Term Debt + Equity and we know that Current Assets = Cash + Other Current Assets, so we can substitute as: Cash + Other Current Assets - Current Liabilities = Long-Term Debt + Equity - Fixed Assets Then finally write in terms of cash: Cash = Long-Term Debt + Equity - Net Working Capital (excluding cash) - Fixed Assets 26.2 a. Decrease b. Decrease c. No change d. Increase e. No change f. No change g. Increase h. No change i. Increase j. Decrease k. Increase l. No change m. No change n. No change o. Decrease p. Decrease q. No change r. Decrease 26.3 Sources and Uses of Cash 20X6 Sources of cash: Cash from operations Net income $68,600 Depreciation 5,225 Decrease in net working capital Increase in accounts payable 5,500 New stock 3,000 Total sources of cash $82,325 Uses of cash: Increase in fixed assets $12,725 Dividends 30,800 Increase in net working capital Investment in inventory 3,750 Increase in accounts receivable 9,750 Decrease in accrued expenses 3.300 Decrease in long-term debt 15,000 Total uses of cash $75,325 Change in cash balance $7,000 26.4 Following example in Tables 26.1 & 26.2: Sources and Uses of Cash 20X6 Sources of cash: Cash from operations Net income $83,000 Depreciation 50,000 Total cash flow from operations 133,000 Decrease in net working capital Decrease in inventory 114,000 Increase in accounts payable 23,000 Increase in loans payable 376,000 Total sources of cash $646,000 Uses of cash: Increase in fixed assets $139,000 Dividends 100,000 Increase in net working capital Increase in accounts receivable 251,000 Decrease in taxes payable 132,000 Decrease in accrued expenses 11,000 Total uses of cash $633,000 Change in cash balance $13,000 26.5 First find the applicable component ratios: Inventory turnover ratio = Receivable turnover ratio = Accounts payable turnover ratio = Days in inventory = Days in receivables = Days in payables = a. Operating cycle = b. Cash cycle = 26.6 a. The operating cycle begins when inventory stock arrives at a firm and ends when cash is collected from receivables. The operating cycle is also the sum of the cash cycle and the accounts payable period. b. The cash cycle begins when cash is paid for materials and ends when cash is collected from receivables. The cash cycle is the time between cash disbursement and cash collection. c. The accounts payable period is the length of time the firm is able to delay payment on the purchase of manufacturing resources. 26.7 Cash cycle Operating cycle a. Decrease No change b. No change Decrease c. Increase No change d. Decrease Decrease e. Increase Increase f. Decrease Decrease 26.8 a. A flexible short-term financing policy maintains a high ratio of current assets to sales. The policy includes limited use of short-term debt and heavy reliance on long-term debt. b. A restrictive short-term financing policy entails a low ratio of current assets to sales. This policy relies upon the use of short-term liabilities. c. If carrying costs are low and/or shortage costs are high, a flexible short-term financing policy is optimal. d. If carrying costs are high and/or shortage costs are low, a restrictive short-term financing policy is optimal. 26.9 Shortage costs are those costs incurred by a firm when its investment in current assets is low. These costs are of two types. i. Trading or order costs. Order costs are the costs of placing an order for more cash or more inventory. ii. Costs related to safety reserves. These costs include lost sales, lost customer goodwill and disruption of production schedules. 26.10 a. The current assets of Cleveland Compressor are financed largely by retained earnings. From 20X1 to 20X2, total current assets grew by $7,212. Only $2,126 of this increase was financed by the growth of current liabilities. Pnew York Pneumatic’s current assets are largely financed by current liabilities. Bank loans are the most important of these current liabilities. They grew $3,077 to finance an increase in current assets of $8,333. b. Cleveland Compressor holds the larger investment in current assets. It has current assets of $92,616 while Pnew York Pneumatic has $78,434 in current assets. The main reason for the difference is the larger sales of Cleveland Compressor. 26.10 (continued) c. Cleveland Compressor is more likely to incur shortage costs because the ratio of current assets to sales is 0.57. That ratio for Pnew York Pneumatic is 0.86. Similarly, Pnew York Pneumatic is incurring more carrying costs for the same reason, a higher ratio of current assets to sales. 26.11 A long-term growth trend in sales will require some permanent investment in current assets. Thus, in the real world, net working capital is not zero. Also, the variation across time for assets means that net working capital is unlikely to be zero at any point in time. 26.12 a. To solve this problem you must assume that all sales are on credit and the remaining 30% of credit sales (100% - 30% - 40%) are never collected. They are bad debts that are written off the books. Let S be the sales in December. 30% of S will be collected in December and 40% of S will be collected in January. You are told that the balance of Account Receivables at the end of December is $36,000, and $30,000 of that amount is uncollected December sales. Since 30% of December sales are collected in December, that $30,000 must be 70% of December sales: 0.7S = $30,000 S = $42,857 b. December January February March Credit sales $42,875 $90,000 $100,000 $120,000 .3(42875) .3(90000) .3(100000) .3(120000) Collections of current month =12,875 =27,000 =30,000 =36,000 .4(42875) .4(90000) .4(100000) Collections of previous month =17,143 =36,000 =40,000 January: $27,000 + $17,143 = $44,143 February: $30,000 + $36,000 = $66,000 March: $36,000 + $40,000 = $76,000 26.13 Quarter 1 2 3 4 Sales (basic trend), millions 100 120 144 172.8 Seasonal adjustments 0 -10 -5 15 Sales projections 100 110 139 187.8 Collection within month 30 33 41.7 56.34 30% of current month adj sales Collection next month 50 55 69.5 50% of previous month adj sales Cash Collection from Sales 83 96.7 125.84 26.14 First find the total collections of each month of the quarter: Credit sales and Collections Second Quarter, 20X5 March April May June Credit sales $180,000 $160,000 $140,000 $192,000 Collections of current month 80,000 70,000 96,000 50% of current sales Collections of previous month 72,000 64,000 56,000 40% of previous sales Total Collections $152,000 $134,000 $152,000 Now, apply those data with those provided in the problem to complete the cash budget: Cash Budget Second Quarter, 20X5 April May June Beginning cash balance $200,000 $226,000 $282,000 Cash receipts: Collections 152,000 134,000 152,000 Total cash available $352,000 $360,000 $434,000 Cash disbursements: Pay credit purchases $65,000 $68,000 $64,000 Wages, taxes, expenses 8,000 7,000 8,400 Interest 3,000 3,000 3,000 Equipment purchases 50,000 0 4,000 Total cash disbursed $126,000 $78,000 $79,400 Ending cash balance $226,000 $282,000 $354,600 26.15 The considerations in determining the most appropriate amount of short-term borrowing are: i. Cash reserves. Flexible financing strategy can reduce financial distress possibility, but it may reduce the return on equity. ii. Maturity hedging. Financing long-term assets with short-term borrowing is inherently risky as the short-term interest rate is more volatile. iii. Term structure. On average, long-term borrowing is more costly than short-term borrowing. 26.16 Short-term external financing options include: i. unsecured loans that can be either committed or uncommitted lines of credit. ii. secured loans that include blanket inventory lien, trust receipt, field-warehouse financing etc. iii. other sources like banker’s acceptances, commercial paper, ..., etc. B-430