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In-Class Exercises 3

# In-Class Exercises 3 - flow from operations How Much...

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Problem #1 d. Problem #1 e. Problem #1 f. In-Class Exercises 1

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Financial Flexibility 2 Financial Flexibility is related to a firm’s overall financial structure and if financial policies allow it enough flexibility to take advantage of unforeseen opportunities. A flexible short-term financial policy would maintain a high level of current assets to sales, such as: Maintaining large cash balances. Maintaining large inventory levels. Offering liberal credit terms, leading to higher receivable levels.
Lambda 3 Lambda measures the likelihood that a firm will exhaust its liquid resources. Initial Liquid Total Anticipated Net Cash Flow Reserve + During Planning Horizon Lambda = -------------------------------------------------------------- Uncertainty About the Net Cash Flow During Planning Horizon Lambda includes information about the volatility of expected cash flows. Historical data is used to calculate the denominator, using the standard deviation of the distribution of the firm’s expected net cash flow from operations.

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Unformatted text preview: flow from operations. How Much Liquidity Is Enough? 4 LAMBDA In Left Tail LAMBDA In Left Tail 1.645 5.00% 2.053 2.00% 1.670 4.75% 2.108 1.75% 1.695 4.50% 2.170 1.50% 1.722 4.25% 2.241 1.25% 1.751 4.00% 2.326 1.00% 1.780 3.75% 2.432 0.75% 1.812 3.50% 2.576 0.50% 1.845 3.25% 2.808 0.25% 1.881 3.00% 2.879 0.20% 1.919 2.75% 2.969 0.15% 1.960 2.50% 3.291 0.10% 2.004 2.25% 3.291 0.05% Probability Probability For example, a Lambda of 1.645 signals a 5% chance of running out of cash. How Much Liquidity Is Enough? 5 • Using Lambda, and based on a firm’s unique circumstances, a firm need only maintain liquid reserves to meet unforeseen circumstances arising from a high degree of uncertainly regarding future cash flows. – If the future is stable, there is a lesser need Current Liquidity Index & Lambda 6 • These two measures have a coverage component similar to the Current Ratio, but they also have a time (or flow) dimension as a result of including a measure of cash flow....
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