RW6eCh19+Sol - CHAPTER 19 CASH AND LIQUIDITY MANAGEMENT...

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CHAPTER 19 CASH AND LIQUIDITY 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. It is debatable whether holding enormous cash reserves is the best way to deal with future economic downturns. However, 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. Cash management is more associated with the collection and disbursement of cash. Liquidity management is broader and concerns the optimal level of liquid assets needed by a firm. Thus, for example, Ford and Chrysler’s stockpiling of cash was liquidity management; whereas, evaluating a lockbox system is cash management. 6. 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. 7. 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. 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 CDs 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 characteristics 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. e. If interest rates rise, the bond drops in price. 9. The concern is that excess cash on hand can lead to poorly thought-out investments. The thought is that keeping cash levels relatively low forces management to pay careful attention to cash flow and capital spending. 10.
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RW6eCh19+Sol - CHAPTER 19 CASH AND LIQUIDITY MANAGEMENT...

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