ch 16_Solutions - Chapter 16 Working Capital Management...

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Unformatted text preview: Chapter 16 Working Capital Management Answers to End-of-Chapter Questions 16-1 The extended DuPont equation is: ROE = Profit margin on sales x Total assets turnover x Leverage factor. A relaxed current assets investment policy means that relatively large amounts of cash, marketable securities, and inventories are carried, and a liberal credit policy results in a high level of receivables. This policy minimizes operating problems, thus the impact on sales is minimized; however, it results in a low assets turnover because assets are increased. Therefore, ROE is reduced. 16-2 The cash conversion cycle is the length of time funds are tied up in working capital, or the length of time between paying for working capital and collecting cash from the sale of the working capital. Holding other things constant, if you reduce the CCC you are reducing the amount of funds tied up. These funds have a cost; therefore, a reduction in funds will lower the firm’s costs and thus raise its profitability. Here we have made an assumption that you can reduce working capital without harming sales. 16-3 When most of us use the term cash, we mean currency (paper money and coins) plus bank demand deposits. However, when corporate treasurers use the term, they often mean currency and demand deposits plus very safe, highly liquid marketable securities that can be sold quickly at a predictable price and thus be converted to bank deposits. Therefore, cash as reported on the balance sheets generally includes short-term securities, which are also called “cash equivalents.” 16-4 Firms need to forecast their cash flows. If they will need additional cash, they should line up funds well in advance, while if they will generate surplus cash, they should plan for its productive use. The primary forecasting tool is the cash budget. Cash budgets can be of any length, but firms typically develop a monthly cash budget for the coming year and a daily cash budget at the start of each month. The monthly budget is good for long-range planning, while the daily budget gives a more precise picture of the actual cash flows. If cash inflows and outflows do not occur uniformly during each month, then the actual funds needed might be quite different from the indicated monthly amounts. The monthly cash budget specifically identifies the amount of cash the firm would have on hand at the end of each month if it neither borrowed nor invested. The treasurer would show the cash budget to the bankers when negotiating for a line of credit. Lenders would want to know Chapter 16: Working Capital Management Answers and Solutions 1 how much the firm expects to need, when the funds will be needed, and when the loan will be...
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This note was uploaded on 11/08/2011 for the course MAT/FIN 272 taught by Professor Burns during the Spring '11 term at Central Connecticut State University.

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ch 16_Solutions - Chapter 16 Working Capital Management...

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