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FIN%204260%20Chapter%203_SLIDES

# FIN%204260%20Chapter%203_SLIDES - 1 Part I Introduction to...

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Part I - Introduction to Liquidity Chapte rs Covere d Chapter 1 The Role of Working Capital Chapter 2 Solvency, Liquidity & Financial Flexibility Chapter 3 Valuation 1

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Cost of Cash Conversion Period 2 Let’s first establish the cost of working capital. Assume a firm offers standard 30-day credit terms (it gets paid for sales 30- days after the sale is made). Assuming average daily sales are \$200,000 and the cost of capital is 10%, what is the annual cost of extending credit ? 30 × \$200,000 × 10% = \$600,000
Valuation of ST Cash Flows 3 Each component of working capital (inventory, receivables, payables) has two dimensions  time and money . It might seem that valuing present year cash flows is not meaningful. However, financial policy decisions that are permanent are meaningful. ST financial decisions can impact firm value by:

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Valuation of ST Cash Flows 4 A widely-used valuation method is the Net Present Value (NPV) approach. This approach is preferred since it accounts for the timing and risk of cash flows. There are four steps: Determine the relevant cash flows. Determine the timing of the cash flows. Determine the appropriate discount rate.
Valuation (NPV) Approach 5 Firm XYZ is considering modifying its credit terms from net 30 to net 60 . Relaxing the credit terms and giving customers more time to pay is expected to increase sales. What is the NPV of this decision? First, let’s recall how to discount money (calculate the present value of future cash flows).

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Discounting ST Cash Flows 6 Other finance classes emphasize the importance of compounding in financial analysis. While this is meaningful for long-term (LT) decisions, simple interest calculations are adequate for ST decisions. We will often use a daily interest rate since firms invest in overnight investments or borrow money on credit lines daily.
Quick TVM Review 7 To calculate PV using simple interest , the formula is: PV = FV / [1 + ( k )( n )] < ANNUAL formula Where k = annual interest rate and n = # of years To modify the formula for a daily periodic interest rate: PV = FV / [1 + ( k )( n /365)] Annual rate times portion of year or

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Choosing the Discount Rate 8 Throughout the course, we will refer to k’ as: The annual interest rate The discount rate
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FIN%204260%20Chapter%203_SLIDES - 1 Part I Introduction to...

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