15 95450 the payment in each period is 30 percent of

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: 0 $10 $45 0 5 $5 $5 $50 0 0 $0 $0 $55 5 –5 $0 $0 $60 10 –10 $0 $0 The payoffs for the combined position are exactly the same as those of owning a put. This means that, in general, the relationship between puts, calls, and forwards must be such that the cost of the two strategies will be the same, or an arbitrage opportunity exists. In general, given any two of the instruments, the third can be synthesized. 498 CHAPTER 26 SHORT-TERM FINANCE AND PLANNING Answers to Concepts Review and Critical Thinking Questions 1. These are firms with relatively long inventory periods and/or relatively long receivables periods. Thus, such firms tend to keep inventory on hand, and they allow customers to purchase on credit and take a relatively long time to pay. These are firms that have a relatively long time between the time that purchased inventory is paid for and the time that inventory is sold and payment received. Thus, these are firms that have relatively short payables periods and/or relatively long receivable cycles. a. b. c. d. e. 4. Use: Source: Use: Use: Use: The cash balance declined by $200 to pay the dividend. The cash balance increased by $500, assuming the goods bought on payables credit were sold for cash. The cash balance declined by $900 to pay for the fixed assets. The cash balance declined by $625 to pay for the higher level of inventory. The cash balance declined by $1,200 to pay for the redemption of debt. 2. 3. Carrying costs will decrease because they are not holding goods in inventory. Shortage costs will probably increase depending on how close the suppliers are and how well they can estimate need. The operating cycle will decrease because the inventory period is decreased. Since the cash cycle equals the operating cycle minus the accounts payable period, it is not possible for the cash cycle to be longer than the operating cycle if the accounts payable is positive. Moreover, it is unlikely that the accounts payable period would ever be negative since that implies the firm pays its bills before they are incurred. Shortage costs are those costs incurred by a firm when its investment in current assets is low. There are two basic types of shortage costs. 1) Trading or order costs. Order costs are the costs of placing an order for more cash or more inventory. 2) Costs related to safety reserves. These costs include lost sales, lost customer goodwill, and disruption of production schedules. A long-term growth trend in sales will require some permanent investment in current assets. Thus, in the real world, net working capital is not zero. Also, the variation across time for assets means that net working capital is unlikely to be zero at any point in time. This is a liquidity reason. It lengthened its payables period, thereby shortening its cash cycle. 5. 6. 7. 8. 9. Their receivables period increased, thereby increasing their operating and cash cycles. 10. It is sometimes argued that large firms “take advantage of” smaller firms by threatening to take their business elsewhere. However, considering a move to another supplier to get better terms is the nature of competitive free enterprise. 11. They would like to! The payables period is a subject of much negotiation, and it is one aspect of the price a firm pays its suppliers. A firm will generally negotiate the best possible combination of payables period and price. Typically, suppliers provide strong financial incentives for rapid payment. This issue is discussed in detail in a later chapter on credit policy. 12. BlueSky will need less financing because it is essentially borrowing more from its suppliers. Among other things, BlueSky will likely need less short-term borrowing from other sources, so it will save on interest expense. Solutions to Questions and Problems NOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiple steps. Due to space and readability constraints, when these intermediate steps are included in this solutions manual, rounding may appear to have occurred. However, the final answer for each problem is found without rounding during any step in the problem. Basic 1. a. No change. A dividend paid for by the sale of debt will not change cash since the cash raised from the debt offer goes immediately to shareholders. b. No change. The real estate is paid for by the cash raised from the debt, so this will not change the cash balance. c. No change. Inventory and accounts payable will increase, but neither will impact the cash account. d. Decrease. The short-term bank loan is repaid with cash, which will reduce the cash balance. e. Decrease. The payment of taxes is a cash transaction. f. Decrease. The preferred stock will be repurchased with cash. g. No change. Accounts receivable will increase, but cash will not increase until the sales are paid off. h. Decrease. The interest is paid with cash, which will reduce the cash balance. i. Increase. When payments for previous sales, or accounts receivable, are paid off, the cash balance increases since the payment must be made in cash. j. Decrease....
View Full Document

This note was uploaded on 07/10/2010 for the course FIN 6301 taught by Professor Eshmalwi during the Spring '10 term at University of Texas-Tyler.

Ask a homework question - tutors are online