BD_SM26 - Chapter 26 Working Capital Management 26-1. a. A...

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Unformatted text preview: Chapter 26 Working Capital Management 26-1. a. A firms cash cycle is the average length of time from when a firm pays cash for its inventory to when it receives cash from the sale of that inventory (or the end product that the firm produced with the inventory.) It is calculated as the average number of days between the purchase of the initial inventory and the sale of the end product plus the average number of days it takes the firms customers to pay cash for the inventory they purchase minus the average number of days the firm takes to pay its suppliers for the inventory. A firms operating cycle is the average length of time between when a firm purchases its inventory and when the firm receives cash from the sale of the inventory. It is calculated as the average number of days between the purchase of the initial inventory and the sale of the end product plus the average number of days it takes the firms customers to pay for the inventory they purchase. If a firm were to pay cash for its inventory, rather than buying the inventory on credit, the cash cycle and the operating cycle of the firm would be identical. In most cases, however, firms buy their inventory on credit, so the cash cycle is shorter than the operating cycle of the firm. b. If a firm increases its inventory, its inventory days will increase, all else equal. This will, therefore, increase the cash cycle of the firm. c. If a firm begins to take discounts offered by its suppliers, its accounts payable days will decrease. All else equal, this will cause the cash cycle of the firm to increase. 26-2. No. An increase in a firms cash cycle does not necessarily mean that the firm is managing its cash poorly. The increase may be due to a conscious management decision. For example, a firm may decide to increase its inventory in order to avoid excessive stock-outs that it has been experiencing. All else equal, this would result in an increase in its cash cycle. Or, a firm may decide to loosen its credit policy in order to attract customers from its competitors. This would result in an increase in accounts receivable days, and all else equal, result in an increase in the firms cash cycle. And if a firm chooses to take the discounts offered by its suppliers, the accounts payable days will decrease, leading to an increase in the firms cash cycle. 26-3. Ignoring revenues and other expenses associated with the new plant, the NPV of the $2 million investment in net working capital is simply the present value of the $2 million that the firm will recoup at the end of ten years minus the initial $2 million investment....
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This note was uploaded on 12/28/2009 for the course FEWEB CORPFIN taught by Professor Dorsman during the Spring '09 term at Vrije Universiteit Amsterdam.

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BD_SM26 - Chapter 26 Working Capital Management 26-1. a. A...

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