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AUBURN FINC 3610 - Chap17 notes

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Chapter 18 May 0411Working Capital Management2Chapter Outline Cash and Marketable Securities Credit and Receivables Inventory Management3Why a Company Holds CashMotives for Holding CashTransactions MotiveAbility to pay expected bills in a timely mannerCompensating Balancesrequired by many banksPrecautionary MotiveAbility to pay unexpected expenses. Keep cash balances on hand to be able to pay without having to sell off other assets on a moments notice.Speculative MotiveKeep cash on hand to be able to take advantage of potential profit-making opportunities in the future.4Optimal Cash BalancesHow quickly and cheaply a firm can raise cash when needed.How accurately managers can predict cash requirements.How much precautionary cash the managers need for emergencies.Investment OpportunitiesThe size of the cash balance depends on:Chapter 18 May 0425Marketable Securities Holding of CashNon-Interest BearingMarketable SecuritiesConsiderations in Using Marketable SecuritiesFinancial Risk (i.e. Default Risk)Interest Rate RiskLiquidityTaxabilityYields6Composition of Marketable Securities PortfolioMarketable SecuritiesU.S. Treasury BillsFederal Agency SecuritiesNegotiable Certificates of DepositCommercial PaperMoney Market Mutual Funds7Credit Management: Key IssuesGranting credit increases salesCosts of granting creditChance that customers won’t payFinancing receivablesCredit management examines the trade-off between increased sales and the costs of granting credit8Accounts Receivable ManagementSpeeding up Collection PolicyTrade DiscountsLate ChargesAdvantage of Slower CollectionsEncourage SalesChapter 18 May 0439Sources of Short Term CreditCost of Trade Credit Typically receive a discount if pay accounts payable early. Stated as: 2/10, net 60 Purchaser receives a 2% discount if pay within 10 days of receiving invoice, otherwise due within 60 days.Credit periodBegincreditperiodDiscountperiodDiscountamountdueFinancingperiodFullamountdue0 10 days 20 30 40 50 6010Sources of Short Term CreditCost of Trade Credit Typically receive a discount if pay accounts payable early. Stated as: 2/10, net 60 Purchaser receives a 2% discount if pay within 10 days of receiving invoice, otherwise due within 60 days.By offering the discount for early payment costs the firm 14.9% APR for those customers who make early payment= .02.98x36560-10APRDiscount%(1–Discount%) 365Credit Out. – Discount Periodx= APR= 0.1490 = 14.9% –1 = EAR = .149 7.30 7.301 + ()0.1589 = 15.89%11Inventory ManagementCosts of Inventory Carrying CostsCost of CapitalStorage and HandlingInsuranceProperty TaxesDepreciation and ObsolescenceOrdering, Shipping and ReceivingCost of placing orders or production set-upShipping and handling costsCosts of Running ShortLoss of salesLoss of customer goodwillDisruption of production schedules12Inventory ManagementTimeInventoryLevel(units)OrderQuantityQAverage Inventory =Order Quantity2Q2=Inventory ExampleChapter 18 May 04413Inventory ManagementTotalInventoryCostsTotalCarryingCostsTotalRestockingCosts=+TotalInventoryCosts=+Q2( )CCTQ( )FWhere:Q=Order SizeT=Total Sales/yearCC=Unit Carrying CostF=Fixed Cost per OrderInventory Example* Ignore costs of inadequate inventory14Inventory ManagementExample:Mayberry Motors expects to sell 1,200 new automobiles in the next year. It currently costs $26 per order placed with the manufacturer. Carrying costs amount to $75 per auto.Inventory ExampleTotalInventoryCosts=+Q2( )CCTQ( )FIf Mayberry places 50 orders per year:Q = = 24 cars per order1,20050242Carrying Costs(75) = 900 1,300120024(26)OrderingCosts= $2,200+ 15Inventory ManagementDetermining Optimal InventoryThe ordering quantity that minimizes the total costs of inventory. Q* =2T x FCCExample:Mayberry Motors expects to sell 1,200 new automobiles in the next year. It currently costs $26 per order placed with the manufacturer. Carrying costs amount to $75 per auto.=2(1200) x 2675= 28.84 cars/order16Inventory ManagementExample:Mayberry Motors expects to sell 1,200 new automobiles in the next year. It currently costs $26 per order placed with the manufacturer. Carrying costs amount to $75 per auto.Inventory ExampleTotalInventoryCosts=+Q2( )CCTQ( )FOptimal Order Quantity = 28.84 use 29 cars/orderQ = = 29 cars per order1,200?292Carrying Costs(75) = 1087.50 1,075.86120029(26)OrderingCosts= $2,163.36+ 42 orders placed per


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