Short-Term Financing

Question 1

Given the following financial statements for firm X:

Firm X pays no dividends. *****Calculate the Internal Growth Rate****

Answer 1

IGR = NI/Assets: IGR = 200/1200 = 16.7%

Question 2

Given the following financial statements for firm X:

Firm X pays no dividends. ***********Assume a cost of debt Rd = 5%. Calculate the Sustainable Growth Rate for the following values of the leverage ratio: 2:1, 3:1, 4:1, 5:1. (Pay attention: ROE and ROA are not independent of leverage!)

Answer 2

Leverage Debt ICR NI SGR Assets * (Leverage - 1) / Leverage Pretax Inc / (Leverage * Rd) (Pretax Inc - Leverage * Rd)*(1-Tax Rate) Net Inc / (Equity - Leverage) 2 600 8.33 176 29.3% 3 800 6.25 168 42.0% 4 900 5.56 164 54.7% 5 960 5.21 161.6 67.3%

Question 3

Given the following financial statements for firm X:

Firm X pays no dividends ************If Firm X needs to maintain an Interest Coverage Ratio (defined as EBIT/Interest Expense) of at least 5.5 to keep its current credit rating, what is its highest feasible leverage ratio among the ones above? What is the associated Sustainable Growth Rate?

Answer 3

4:1 is the highest as the Interest Coverage Ratio [Pretax Inc / (Leverage * Rd)] is 5.56; associated SGR is 54.7%

Question 4

Answer 4

Question 5

Answer 5

Question 6

One of the suppliers says: “This is nonsense. An increase in accounts payable is a one-time cash flow, not a sustainable way to finance growth. This is just a cash grab.” Discuss in maximum 20 words.

Answer 6

Has “One-Time” cash component, but it is not JUST a cash grab, because the IGR is now higher.

Question 7

What is the formula for free cash flow?

Answer 7

Question 8

What is the formula for financial cash flows?

Answer 8

TBD

Question 9

Together, how do FCF and Financial Cash Flow quantities explain changes in cash?

Answer 9

TBD

Question 10

Firm X operates in a perfect Modigliani-Miller world. The CEO says: “We pledged out accounts receivable as collateral to obtain a loan from Bank Q. This will reduce our cost of capital, as the cost of this loan is lower than the cost of all other loans we have outstanding.” What is wrong with this?

Answer 10

A/R as collateral:

• Pledging of A/R

Question 11

Firm X operates in a perfect Modigliani-Miller world. The CEO says: “We pledged out accounts receivable as collateral to obtain a loan from Bank Q. This will reduce our cost of capital, as the cost of this loan is lower than the cost of all other loans we have outstanding.” Would it be different if the accounts receivable were sold to a factor? Explain in maximum 20 words.​

Answer 11

Factoring

With or without recourse (ELABORATE)

Question 12

Firm X operates in a perfect Modigliani-Miller world. The CEO says: “We pledged out accounts receivable as collateral to obtain a loan from Bank Q. This will reduce our cost of capital, as the cost of this loan is lower than the cost of all other loans we have outstanding.”

Which of the following assets is the best collateral? (Mark all correct)

• i. Accounts receivable
• ii. Inventory
• iii. Accounts payable
• iv. Deferred tax assets

Answer 12

• A/R as collateral:
  
  • Pledging of A/R
  • Factoring
    
    • With or without recourse
• Inventory as collateral:
  
  • Floating lien (general inventory)
  • Trust receipt loan (specific items)
  • Warehouse arrangement (items held in 3rd-party warehouse)

Question 13

The Fast Reader Company supplies bulletin board services to numerous hotel chains nationwide. The owner of the firm is investigating the benefit of employing a billing firm to do her billing and collections. Because the billing firm specializes in these services, collection float will be reduced by 17 days.

Average daily collections are $1,350, and the owner can earn 8% annually (expressed as an APR with monthly compounding) on her investments.

If the billing firm charges $250 per month, should the owner employ the billing firm?

Answer 13

TBD

Question 14

What are the permanent working capital needs of your company? What are the temporary needs?

Answer 14

TBD

Question 15

The cost of NWC Emerald City Paints would like to construct a new facility that will manufacture paint. In addition to the capital expenditure on the plant, management estimates that the project will require an investment today of $450,000 for net working capital. The firm will recover the investment in net working capital eight years from today, when management anticipates closing the plant. The discount rate for this type of cash flow is 6% per year.

• What is the present value of the cost of working capital for the paint facility?
• What is the value of an inventory policy that would halve the plant’s net working capital requirements?

Answer 15

TBD

Question 16

The cost of trade credit

What is the cost of trade credit implicit in terms of 1.5/10 Net 45?

What if I take 60 days to pay? (Assume 365 days in a year).

Answer 16

Trade credit terms are expressed as “[d/T1] Net T2”, where d is the early payment discount percentage, T1 is the discount deadline in days, and T2 is the ultimate deadline.

E.g.:

• Net 45: payment due 45 days from invoice receipt
• 1.5/10 Net 45: payment due 45 days from invoice receipt. If payment is remitted within 10 days, there is a 1.5% discount.

Example: implicit interest rate in 2/10 Net 30.

****************************************CHECK THE WORK BELOW!!*****

First 10 days: 0 interest

Next 35 days:

Total return on the loan: 1.5/(100−1.5) =1.52%

EAR = 1.015^35/365−1=0.0019%!!!

What if I take my time and pay in 60 days?

EAR = 1.020305^50/365−1=0.0028%.

Still pretty expensive!

These are pretty standard terms, behavior. Why do firms do it?