Chapter 18 May 0411Working Capital Management2Chapter Outline Cash and Marketable Securities Credit and Receivables Inventory Management3Why a Company Holds CashMotives for Holding CashTransactions MotiveAbility to pay expected bills in a timely mannerCompensating Balancesrequired by many banksPrecautionary MotiveAbility 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 MotiveKeep cash on hand to be able to take advantage of potential profit-making opportunities in the future.4Optimal Cash BalancesHow 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 CashNon-Interest BearingMarketable SecuritiesConsiderations in Using Marketable SecuritiesFinancial Risk (i.e. Default Risk)Interest Rate RiskLiquidityTaxabilityYields6Composition of Marketable Securities PortfolioMarketable SecuritiesU.S. Treasury BillsFederal Agency SecuritiesNegotiable Certificates of DepositCommercial PaperMoney Market Mutual Funds7Credit Management: Key IssuesGranting credit increases salesCosts of granting creditChance that customers won’t payFinancing receivablesCredit management examines the trade-off between increased sales and the costs of granting credit8Accounts Receivable ManagementSpeeding up Collection PolicyTrade DiscountsLate ChargesAdvantage of Slower CollectionsEncourage 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 CostsCost of CapitalStorage and HandlingInsuranceProperty TaxesDepreciation and ObsolescenceOrdering, Shipping and ReceivingCost of placing orders or production set-upShipping and handling costsCosts of Running ShortLoss of salesLoss of customer goodwillDisruption 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 InventoryThe 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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