Corporate_Finance_9th_edition_Solutions_Manual_FINAL0

76 the net cash flow per check is the net cash flow

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Unformatted text preview: eived for each quarter: Q1: excess funds at start of quarter of $54 invested for 1 quarter earns .02($54 = $1.08 income Q2: excess funds of $66.68 invested for 1 quarter earns .02($66.68) = $1.33 in income Q3: excess funds of $18.46 invested for 1 quarter earns .02($18.46) = $0.37 in income Q4: excess funds of $26.13 invested for 1 quarter earns .02($26.13) = $0.52 in income Net cash cost = $1.08 + 1.33 + 0.37 + 0.52 = $3.31 Since cash has an opportunity cost, the firm can boost its profit if it keeps its minimum cash balance low and invests the cash instead. However, the tradeoff is that in the event of unforeseen circumstances, the firm may not be able to meet its short-run obligations if enough cash is not available. 511 15. a. The current assets of Cleveland Compressor are financed largely by retained earnings. From 2009 to 2010, total current assets grew by $7,212. Only $2,126 of this increase was financed by the growth of current liabilities. Pnew York Pneumatic’s current assets are largely financed by current liabilities. Bank loans are the most important of these current liabilities. They grew $3,077 to finance an increase in current assets of $8,333. Cleveland Compressor holds the larger investment in current assets. It has current assets of $92,616 while Pnew York Pneumatic has $78,434 in current assets. The main reason for the difference is the larger sales of Cleveland Compressor. Cleveland Compressor is more likely to incur shortage costs because the ratio of current assets to sales is 0.57. That ratio for Pnew York Pneumatic is 0.86. Similarly, Pnew York Pneumatic is incurring more carrying costs for the same reason, a higher ratio of current assets to sales. b. c. 512 CHAPTER 27 CASH 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 10 discusses another reason. 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. Probably not. Creditors would probably want substantially more. Cash management is associated more 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, a company’s stockpiling of cash is liquidity management; whereas, evaluating a lockbox system is cash management. 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 socalled adjustable rate preferred stock very attractive relative to interest-bearing instruments. 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. 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. a. b. c. d. About the only disadvantage to holding T-bills are the generally lower yields compared to alternative money market investments. Some ordinary preferred stock issues pose both credit and price risks that are not consistent with most short-term cash management plans. 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. 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. The primary disadvantages of RANs is that some possess non-trivial levels of default risk, and also, corporations are somewhat restricted in the type and amount of these tax-exempts that they can hold in their portfolios. 2. 3. 4. 5. 6. 7. 8. e. f. 9. The primary disadvantage of the repo market is the generally very short maturities available. The concern is that excess cash on hand can lead to poorly thought-out management decisions. The thought is that keeping cash levels relatively low forces management to pay careful attention to cash flow and capital spending. 10. A potential advantage is that the quicker payment often means a better price. The disadvantage is that doing so increases the firm’s cash cycle. 11. This is really a capital structure decision. If the firm has an optimal capital structure, paying off debt moves it to an under-leveraged position. However, a combination of debt reduction and stock buybacks could be structured to...
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