Ch. 15: Introduction to Management

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Ch. 15 Introduction to Management
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Working-Capital Management

• Current Assets
• cash, marketable securities, inventory, accounts
  receivable
• Long-Term Assets
• equipment, buildings, land
• Which earn higher rates of return?
• Which help avoid risk of illiquidity?

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Working-Capital Management

• Current Liabilities
• short-term notes, accrued expenses, accounts
  payable
• Long-Term Debt and Equity
• bonds, preferred stock, common stock
• Which are more expensive for the firm?
• Which increase the risk of illiquidity?

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• Balance Sheet
• Current Assets Current Liabilities
• Fixed Assets Long-Term Debt
• Preferred Stock
• Common Stock
• Suppose we use long-term financing to finance
  some of our current assets.
• This strategy would be less risky, but more
  expensive!

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• Balance Sheet
• Current Assets Current Liabilities
• Fixed Assets Long-Term Debt
• Preferred Stock
• Common Stock
• Suppose we use current liabilities to finance
  some of our fixed assets.
• This strategy would be less expensive, but more
  risky!

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The Hedging Principle

• Permanent Assets (those held gt 1 year)
• should be financed with permanent and spontaneous
  sources of financing.
• Temporary Assets (those held lt 1 year)
• should be financed with temporary sources of
  financing.

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• Balance Sheet
• Temporary Temporary
• Current Assets Short-term financing
• Permanent Permanent
• Fixed Assets Financing
• and
• Spontaneous
• Financing

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The Hedging Principle

• Permanent Financing
• intermediate-term loans, long-term debt,
  preferred stock, common stock
• Spontaneous Financing
• accounts payable that arise spontaneously in
  day-to-day operations (trade credit, wages
  payable, accrued interest and taxes)
• Short-term financing
• unsecured bank loans, commercial paper, loans
  secured by A/R or inventory

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Cost of Short-Term Credit

• Interest principal x rate x time
• ex borrow 10,000 at 8.5 for 9 months
• Interest 10,000 x .085 x 3/4 year
• 637.50

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Cost of Short-Term Credit

• We can use this simple relationship
• Interest principal x rate x time
• to solve for rate, and get the
• Annual Percentage Rate (APR)
• interest 1
• principal time

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Cost of Short-Term Credit

• interest
  1
• principal time
• example If you pay 637.50 in interest on
  10,000 principal for 9 months
• APR 637.50/10,000 x 1/.75 .085
• 8.5 APR

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Cost of Short-Term Credit

• Annual Percentage Yield (APY) is similar to APR,
  except that it accounts for compound interest
• i m
• m
• i the nominal rate of interest
• m the of compounding periods per year

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Cost of Short-Term Credit

• What is the (APY) of a 9 loan with monthly
  payments?
• APY ( 1 ( .09 / 12 ) 12 -1 ) .0938
• 9.38

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Sources of Short-term Credit

• Unsecured
• accrued wages and taxes
• trade credit
• bank credit
• commercial paper
• Secured
• accounts receivable loans
• inventory loans

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Cash Conversion Cycle

• Days of Sales Outstanding
• (Accts. Rec. / Ave. Daily Sales)
• Days of Sales in Inventory
• (Inventories / Ave. Daily Sales)
• - Days of Payables Outstanding
• (Accts. Pay. / Ave. Daily Sales)