ch17_sm - CHAPTER17 WORKINGCAPITALMANAGEMENT Answers to...

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CHAPTER 17 WORKING CAPITAL MANAGEMENT Answers to Concepts Review and Critical Thinking Questions 1. Yes. Once a firm has more cash than it needs for operations and planned expenditures, the excess cash has an opportunity cost. It could be invested (by shareholders) in potentially more profitable ways. Question 9 discusses another reason. 2. If it has too much cash it can simply pay a dividend, or, more likely in the current financial environment, buy back stock. It can also reduce debt. If it has insufficient cash, then it must either borrow, sell stock, or improve profitability. 3. Probably not. Creditors would probably want substantially more. 4. Auto manufacturers often argue that due to the cyclical nature of their business, cash reserves are a good way to deal with future economic downturns. This is debatable, but it is true that auto manufacturers’ operating cash flows are very sensitive to the business cycle, and enormous losses have occurred during recent downturns. 5. Such instruments go by a variety of names, but the key feature is that the dividend adjusts, keeping the price relatively stable. This price stability, along with the dividend tax exemption, makes so- called adjustable rate preferred stock very attractive relative to interest-bearing instruments. 6. Net disbursement float is more desirable because the bank thinks the firm has more money than it actually does, and the firm is therefore receiving interest on funds it has already spent. 7. The firm has a net disbursement float of $500,000. If this is an ongoing situation, the firm may be tempted to write checks for more than it actually has in its account. 8. a. About the only disadvantage to holding T-bills are the generally lower yields compared to alternative money market investments. b. Some ordinary preferred stock issues pose both credit and price risks that are not consistent with most short-term cash management plans. c. The primary disadvantage of NCDs is the normally large transactions sizes, which may not be feasible for the short-term investment plans of many smaller to medium-sized corporations. d. The primary disadvantages of the commercial paper market are the higher default risk charac- teristics of the security, and the lack of an active secondary market which may excessively restrict the flexibility of corporations to meet their liquidity adjustment needs. 9.
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This note was uploaded on 05/01/2009 for the course FINC 106 taught by Professor Dr.nehale during the Spring '09 term at Baptist College of Health Sciences.

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ch17_sm - CHAPTER17 WORKINGCAPITALMANAGEMENT Answers to...

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