P2B.4 WORKING CAPITAL MGMT

Question 1

Equation: Reorder point

Answer 1

[Average Daily Usage * Average lead time in days] + Safety stock

Question 2

What are ways to manage cash outflows?

Answer 2

Zero balance accounts, centralization of payables and controlled disbursements

Question 3

BANK ACCEPTANCE: What is it?

Answer 3

time draft (a promise to pay bearer of draft on a specific date in future once conditions are met)

Used when buyer & seller are complete strangers (i.e. no relationship)

Question 4

Banker’s Acceptance: How is it booked in the banker’s books?

Answer 4

Banker will post banker’s acceptance as a LIABILITY

Question 5

Government-sponsored entities issue bonds that ______ backed by US government

Answer 5

ARE NOT

Question 6

Money markets focus on (short/long) term instruments while capital markets focus on (short/long) term instruments

Answer 6

Money markets: short-term

Capital markets: long-term

Question 7

What is commercial paper?

Answer 7

Unsecured financial instrument issued by a firm with high credit rating

Matures less than 270 days and low cost

Not really for general public

Question 8

List ways to speed UP cash collections

Answer 8

1. Lockbox - this decreases processing time
2. Factoring ARs - firm will get cash immediately
3. Discount within certain days
4. more ways to pay electronically

Question 9

Define Negotiable CD

Answer 9

• lower risk financial instrument than that of commercial paper
• can be sold BEFORE maturity date
• fixed interest rate paid with a maturity date

Question 10

Define: Commercial Paper

Answer 10

• unsecured debt issued by firm with high credit rating
• maturity date of 270 days or less
• not necessarily registered with SEC
• not available to general public usually

Question 11

List Steps of bankers’ acceptance

Answer 11

1. importer buys goods from exporter on agreed upon price
2. importer requests acceptance agreement to its bank
3. Importer’s bank agrees to receive draft on importer’s behalf and importer will repay drafts
4. Exporter ships goods
5. Importer bank sends time draft and shipping dox to exporter’s bank
6. Importer’s bank sends payment to exporter’s bank; bank creats BA
7. Importer pays back its bank in full ON maturity date of BA

Question 12

Define: Factoring

Answer 12

Selling AR to a 3rd party @ a discount

Question 13

Define: Marketability

Answer 13

The ease an investor has to sell a security w/o impairing its value

Question 14

Define: Maturity Risk

Answer 14

Risk that interest rates will go UP when investor is currently locked in a lower interest rate debt instrument

Question 15

Equation: Annual cost of NOT taking a cash discount

Answer 15

[% of discount offered/1-% of discount offered] * (365/# of days of discount period)

Question 16

Equation: Effective Interest Rate of Not taking a cash discount

Answer 16

(1 + periodic rate)ⁿ - 1

where

Periodic rate = (periodic rate/(1 - periodic discount))

Question 17

Definition: Effective Interest Rate of Not taking a cash discount

Answer 17

If firm’s investments > effective interest rate, DO NOT TAKE cash discount

IF < effective interest rate, firm pays buyer early and take discount

Question 18

Equation: Effective A/R with compensating balance

Answer 18

Nominal Interest Due

÷

available principal

Question 19

Equation: Effective AR with commitment fee

Answer 19

[Nominal Interest Due + commitment fee]/principal balance

Question 20

Equation: Annual Carrying Cost of inventory

Answer 20

Carrying per unit * [# of units per order/2]

Question 21

Equation: Annual Ordering Cost of Inventory

Answer 21

Cost per Order * [Annual Demand/# of units per order]

Question 22

List assumptions made for Economic Order Quantity

Answer 22

1. Demand is known & constant throughout entire period
2. Order Cost is FIXED
3. Carrying costs include: obsolescence, interest, insurance, storage and materials
4. Lead time is known & constant
5. stock replenishment is immediate, w/o outages

Question 23

EOQ moves in _____ direction as Annual Sales and Order Cost

Answer 23

SAME

(as Annual Sales and Order Cost go UP, EOQ goes UP)

Question 24

EOQ goes _____ while Carrying Cost per unit goes ______

Answer 24

UP, DOWN

Question 25

Equation: Lockbox benefit

Answer 25

Float reduction in days * Average daily receipts * Interest rate

Question 26

Equation: Financial Leverage Ratio

Answer 26

Total Debt

÷

Total Equity

Question 27

Equation: Equity Multiplier

Answer 27

Total Assets

÷

Total Equity

Question 28

How does Zero Balance Account help the firm?

Answer 28

• It reduces cost of cash management via reducing time managers spend in transferring cash between accounts to cover check balances
• reduces excess cash balance by having the firm only have 1 account to worry about as other accounts are maintained at 0 balances
• reduces mgmt’s time by taking out the time mgmt spends in transferring cash

Question 29

Definition: Speculative Motive

Answer 29

taking advantage of an exploit

Question 30

Definition: Transaction Motive

Answer 30

need for cash to cover business daily opex

Question 31

Definition: Precautionary Motive

Answer 31

action done to reduce risk of an event occurring:

ex: holding more cash in case a client goes BK

Question 32

Equation: Cost of Foregoing Discount

Answer 32

]Discount offered/1-Discount offered] x 365/# of days discount is applicable

Question 33

Equation: Total Inventory Value

Answer 33

Set up costs + holding costs + cost of purchase

Question 34

Equation: set up cost

Answer 34

set up cost x # of units used annually

÷

of units ordered

Question 35

Equation: Holding costs

Answer 35

annual holding cost of 1 unit x # of units ordered

÷

2