Chapter 24 & 25

Question 1

EAR of supplier financing formula

Answer 1

Question 2

What are the ways a company can decrease its CCC?

Answer 2

Decreasing inventories and receivables

OR

Increasing payables.

Question 3

Total Working Capital Formula

Answer 3

Current Assets - Current Liabilities

Question 4

Net Working Capital

Answer 4

current assets
(except cash and marketable securities)
−
current liabilities
(excluding short-term and current debt)

Question 5

Answer 5

Question 6

An increase in the CCC is a reduction in what?

Answer 6

It reduces issuers liquidity

Question 7

drag on liquidity

Answer 7

Drag on liquidity occurs when cash inflows lag (Increase in DOH, DSO)

This can occur when excess inventory builds up or inventory becomes obsolete.

(DOH increases - Days of inventory on hand ),

or

when collections are slow or receivables become uncollectible.

(DSO increases - days sales outstanding).

Question 8

days of inventory on hand

Answer 8

number of days it takes for a company to sell its inventory

Question 9

days sales outstanding

Answer 9

the number of days it takes for the company to collect payment from its customers

Question 10

Current Ratio Formula and what does it mean when its greater than 1?

Answer 10

current assets /
current liabilities

Greater than 1 means company has sufficient current assets to meet its current liabilities.

Question 11

Quick Ratio formula and what does it exclude?

Answer 11

Excludes Inventory because tis least liquid current assets.

Also excludes payables

Question 12

Cash Ratio formula and what does it exclude?

Cash Ratio > 1 suggests what?

Answer 12

Most Conservative

Cash ratio > 1 suggest the co could cover all its ST obligations w/o needing to wait to sell inventory or collect receivables.

Question 13

pull on liquidity

Answer 13

A pull on liquidity occurs when cash outflows accelerate. (reduce credit terms)

This can occur when suppliers reduce credit lines or demand faster payments (DPO decreases)(days payable outstanding)..

Question 14

Features of conservative approach to working capital management.

Pros and Cons

Answer 14

• Hold higher amt of ST assets
• Finance the WC using LT sources like LT debt and Equity
• High WC as % of sales

Pros:
- Using more permanent capital with less need for roll over

• Greater flex during mrk disruptions,
• High probability of meeting ST obligations

Cons:
- Higher costs and lower profitability

• LT lenders may impose constraints like min interest coverage ratio.

Question 15

Aggressive approach to WC and its Pros and Cons

Answer 15

• Low WC as % of sales
• lower levels of ST assets and finance WC using ST debt.

Pros: lower cost
Cons: The risk is failing to meet business obligations and vulnerability to mrk disruptions.

Question 16

Moderate approach to WC

Answer 16

PERMANENT current assets are funded using LT sources of capital.

While VARIABLE/SEASONAL current assets are funded using ST sources

Question 17

Corporate governance

Answer 17

Corporate governance is the system of internal controls and procedures by which individual companies are managed.

It includes a framework that defines the rights, roles, and responsibilities of various groups within an organization.

The objective is to manage and minimize conflicts of interest between stakeholders of the company.

Reduced risk of default is among the benefits of effective corporate governance. Risks from poor corporate governance include related-party transactions by managers and opportunities for some stakeholder groups to gain an advantage at the expense of others.

Question 18

Stakeholder management

Answer 18

Stakeholder management refers to the management of company relations with stakeholders and is based on having a good understanding of stakeholder interests and maintaining effective communication with stakeholders.

Stakeholder theory focuses on the conflicts of interest among owners and several groups that have an interest in a company’s activities, including creditors.

With respect to the company’s relationship with shareholders, there are standard practices. These practices are required by corporate laws and are similar in many jurisdictions

Question 19

Primary Sources of Liquidity

Answer 19

Cash and Mrk Securities on hand

Bank Loans

Cash generated from business

Question 20

EAR Example:

A supplier offers 2/10 net 30 terms. The bank interest rate is 8%. Which source of financing should the company prefer?

Answer 20

Question 21

A company receives an invoice of $150,000 for machine tools with terms of “1.5/15 net 40.” The cost to the company of delaying payment of this receivable is most appropriately described as $2,250 for the use of:

Answer 21

The terms indicate that the company can pay

$150,000(1 − 0.015) = $147,750 on day 15 (after the invoice date)

or

pay $150,000 on day 40—effectively gaining the use of $147,750 for 25 days at a cost of $2,250.

Question 22

A supplier offers 4/30 net 90 terms. The bank interest rate is 6.5%. Which source of financing is the cheapest?

Answer 22

The EAR of supplier financing = (1 + 0.04 / 0.96)365/60 – 1 = 28.2%.

The cost of implicit supplier financing is much higher than the cost of explicit bank financing of 6.5%.

Question 23

Buildup Design, Inc., expects a 20% reduction in its days payable outstanding from 50 to 40 days, while its days of inventory on hand and days sales outstanding would remain unchanged. What would be the most likely impact on the cash conversion cycle (CCC)?

Answer 23

The CCC would increase by 20%.

The CCC is calculated by adding the days of inventory on hand and the days sales outstanding, and subtracting the days payable outstanding.

A shorter days payable outstanding implies less generous credit terms by suppliers, where the company must pay its suppliers in a shorter time period. This would increase the CCC by 10 days.

Question 24

Current Ratio

Quick Ratio

Cash Ratio

And exclusions

Answer 24

Question 25

Cash Conversion Cycle

Operating Cycle

Answer 25

Question 26

Cash Conversion Cycle

Definition

Formula

Interpretation

Answer 26

Question 27

Shortening CCC Methods

Answer 27

Question 28

Calculating CFs

Answer 28

Question 29

Answer 29

Question 30

Which conservative ratio should we look for liquidity?

Answer 30