SU5: Working Capital Flashcards
Net Working Capital
Current Assets - Current Liabilities
Permanent Working Capital
Minimum level of current assets maintained by the firm, usually financed with long term debt.
Current Ratio
Current Assets / Current Liabilities
Quick Ratio or Acid Test Ratio
Quick Assets / Current Liabilities
Economic Order Quantity
sq root of (2bT/i)
b = fixed cost per transaction
T = total demand for cash
i=intrest rate on marketable securities
Annual Benefit of receiving cash earlier
Daily Cash Receipts x Days of Reduced Float x Opportunity Cost of Funds
The three motives for holding cash are
Transactional Motive, precautionary motive and the speculative motive
T-Bills
1 year or less, no coupon rate, sold at a discount
T-Notes
Maturities of 1-10 years, interest paid every 6 months
T-Bonds
Maturities of 10 years or longer. Interest payment every 6 months.
Repos
Repurchase agreement - a means for dealers in government securities to finance their portfolios.
Commercial Paper
Unsecured, short-term ntoes issued by large companies that are very good credit risks
CD’s
Certificate of Deposits - less risky than commercial paper and bankers acceptances
Eurodollars
time deposits of US dollars in banks located abroad
Bankers Acceptance
less risky than commercial paper
CAPM Model
ROR = Rf + B*(Rm-Rf)
Long hedges are purchased to protect against price <> and short hedges are sold to protect against price <>
Long hedges are purchased to protect against price increases, and short hedges are sold to protect against price declines
Economic Order Quantity
= square root of ( 2ad/k)
a= fixed cost per PO (ordering costs)
D=periodic demand in units
k=carrying cost per unit
List the assumptions of the EOQ model
Demand is uniform.
Carrying costs are constant.
The same quantity is ordered at each reorder point.
Purchasing costs are unaffected by the quantity ordered.
Sales are perfectly predictable.
Lead time is known with certainty.
Deliveries are consistent.
Adequate inventory is maintained to avoid stockouts.
Cost of carrying safety stock
=expected stockout cost + carrying cost
Reorder formula
average daily demand x lead time in days + safety stock
List the four types of inventory costs
Purchase Costs, order or setup costs, carrying costs and stockout costs
Equation for effective interest rate on loan with compensating balance
Stated rate divided by (1-stated rate-compensating balance %)
Current Market Value Eq
Next divident divided by (Required Rate of Return - Dividend Growth Rate)
In the context of the capital asset pricing model (CAPM), the beta coefficient of a stock that has the same systematic risk as the market as a whole is equal to
1
List the three main items that contribute to a firms beta value
Debt to equity ratio, Industry characteristics and operating leverage
List the three major motives for holding cash according to Keynes.
i) the transactions-motive, i.e. the need of cash for the current transaction of personal and business exchanges; (ii) the precautionary-motive, i.e. the desire for security as to the future cash equivalent of a certain proportion of total resources; and (iii) the speculative-motive, i.e. the object of securing profit from knowing better than the market what the future will bring forth
Covariance of two stock portfolio eq
correlation coefficient x standard dev of stock A x standard dev of stock B
Risk premium
the risk premium is the difference between the return on market portfolio and the risk free return
An optimal portfolio of investments is
Tangential to the investors highest indifference curve
Describe capital rationing
Capital rationing exists when a firm sets a limit on the amount of funds to be invested during a given period. In such situations, a firm cannot afford to undertake all profitable projects. Another way of stating this is that the firm cannot invest the entire amount needed to fund the theoretically optimal capital budget, so only those projects that will return the greatest net present value for the limited capital available in the internal capital market can be undertaken.
Method for calculating Beta
divide the covariance of the return on the market and the return on the security by the variance of the return on the market
Describe factors that would impact the beta value that is chosen for use in evaluating a project
the inudustry and it’s risk characteristics
experience the division has with similar projects
ability of the division to realize estimated returns on projects in the past
strength of the management team in the division
level of competition expected
geographical location of the project
the degree to which the project involves new technology
Coefficient of variation (as related to returns on a project)
= the standard deviation of a project divided by the expected return
The returns on two stocks can be correlated in values except those that are
Skewed.
The correlation voefficient measures the degree to which to variables are rleated. This can be positive, negative or 0.
The returns on two stocks can be correlated in values except those that are
Beta Coefficient
For a firm engaged in risk management, value-at-risk is defined as the
Maximum loss within a certain time period at a given level of confidence
Things to consider when looking at lease vs buy
Bank covenants, expected rate of obselescence (cancellation clause)
Potential use of asset after useful life
What rate to use in lease vs buy?
Risk free rate.
List the three motives to hold cash
Medium of exchange (transactions), provide a reserve for contingencies (precautionary) and to take advantage of unexpected opportunity (speculative)
