P2B.4 Working Capital Management

Question 1

Working Capital Formula

Answer 1

Management of liquidity to finance the operating cycle.

= Current assets - current liabilities

Question 2

Transactional Motive

Answer 2

1. Relates to the need for cash in day-to-day transactions; medium of exchange.
2. To make payments

Question 3

Precautionary Motive

Answer 3

1. Arises from unexpected cash outflows that a company may be subjected to.
2. Maintain safety cushion

Question 4

Speculative Motive

Answer 4

1. A cash reserve can be used to benefit from advantageous situations in the market.
2. To take advantage of sudden opportunities.

Question 5

Methods of Speeding up Cash Collections

Answer 5

1. Lockbox system
2. Concentration banking
3. Payment methods; preauthorized checks, electronic transfers or automatic debits
4. Payment incentives; discounts
5. Factoring

Question 6

Annual Lockbox Benefit Meaning & Formula

Answer 6

To determine if bank fees associated with a lockbox are less than the accelerated collection of cash.

= Float reduction in days * Average daily receipts * Interest rate

Question 7

Methods for Slowing Down Disbursements

Answer 7

1. Use of checks/drafts
2. Zero Balance Accounts (ZBA)
3. Remote disbursement
4. Controlled disbursement

Question 8

Marketable Securities Types

Answer 8

1. Treasury bills, Notes and Bonds: treasury securities have less default risk.
2. Repurchase agreements
3. Federal Agency securities
4. Bankers’ Acceptance: agreements to pay for transaction guaranteed by bank
5. Commercial paper: unsecured short-term notes
6. Negotiable certificate of deposits
7. Eurodollar certificate of deposits

Question 9

Tax Equivalent Yield

Answer 9

Tax-free investment vs. Taxable investment based on yield.

To determine which investment provides a higher tax-adjusted yield.

Question 10

Tax Equivalent Yield Formula

Answer 10

= Tax-free yield / (1 - marginal tax rate)

Question 11

Factors influencing the level of Accounts Receivables

Answer 11

1. Type or Nature of Business
2. Level of Sales (external)
3. Credit & Collection policies (internal)

Question 12

Net Benefit (Loss) on Planned Change in Credit Policy

Answer 12

1. Benefit (increase in income) = Increase in sales * contribution margin
2. Costs = Additional cost + opportunity cost of additional AR
3. Cost of Additional AR = Increase in AR * Variable cost ratio * Required return

Question 13

Reasons for Carrying Inventory

Answer 13

1. To cater to sudden increase in demand.
2. To reduce stock out costs
3. To take advantage of volume discounts
4. To buffer against unexpected failures in the production process
5. To save from future price increases

Question 14

Reorder Point Formula

Answer 14

= (Average Daily Usage * Average Lead Time in Days) + Safety Stock

Question 15

Total Ordering Costs Formula

Answer 15

= Cost per Order * Number of Orders

= Cost per Order * (Annual Demand / Order Size)

Question 16

Total Carrying Costs Formula

Answer 16

= Carrying Cost per Unit * Average Inventory

= Carrying Cost per Unit * (Order Size / 2)

Question 17

Total Annual Cost of Inventory

Answer 17

= Annual Carrying Cost + Annual Ordering Cost

Question 18

Economic Order Quantity (EOQ)

Answer 18

Optimal number of units to be purchased (or the order size) to minimize the total relevant inventory costs: total ordering costs and total carrying costs.

The assumptions made when using EOQ are:
1. The same quantity will be ordered on each order,
demand, ordering costs, and carrying costs are known and constant,
2. Purchase order lead time is known, and
3. Stockouts will not occur.

Question 19

Economic Ordering Quantity (EOQ) Formula

Answer 19

= Sq root (2 * Annual Demand * Cost per order) / Carrying cost per Unit

Question 20

Short-Term Credit Policy Approach

Answer 20

1. Aggressive: short-term financing for both short & long term assets. An aggressive approach produces a reduced cost of borrowing to fund company operations, because short-term loans carry a lower interest rate.
2. Conservative: long-term financing for both short & long term assets.

Question 21

Cost of Foregoing the Discount

Answer 21

Annual cost of not taking a cash discount.

= D / (1-D) * 365 / N
= Discount turnover * Periodic Discount Rate

D = percentage discount offered
N = number of days of the discount period

Question 22

Effective Interest Rate Formula

Answer 22

= (1 + Periodic rate)n - 1

Question 23

Periodic Rate Formula

Answer 23

= Periodic Discount / (1 - Periodic Discount)

Question 24

Effective Annual Interest Rate of Bank Loan with Compensating Balance

Answer 24

= Nominal interest Due / Available Principal

= (Prin Balance * Interest Rate) / (Total Prin - Comp Balance)

Question 25

Effective A/R with a Commitment Fee

Answer 25

= (Prin Balance * Interest Rate) + Commitment Fee / Prin Balance

Commitment fee = unused portion of line of credit multiplied by commitment fee percentage.

Question 26

More Securities Types

Answer 26

1. Money markets: short term, issued at a discount and the investor earns a return on the difference between the discount amount and the amount received at maturity.
2. Treasury bills: issued at a discount, and the investor earns a return on the difference between the discount amount and the amount received at maturity.
3. Treasury notes: issued at a stated rate of interest, and have a maturity of one to 10 years.
4. Treasury bonds: issued at a stated rate of interest, and have a maturity of one to 10 years. .