Working Capital and the Financing Decision C H A P T E R S I X
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1 Working Capital and the Financing Decision C H A P T E R S I X Limited 2000
2 Figure 6-1a The nature of asset growth A. Stage I: Limited or no Growth PPT 6-1 Dollars Temporary current assets Capital assets Time period Limited 2000
3 Figure 6-1b The nature of asset growth B. Stage II: Growth Dollars Temporary current assets PPT 6-1 Permanent current assets Capital assets Time period Limited 2000
4 Figure 6-1b The nature of asset growth B. Stage II: Growth Dollars Temporary current assets PPT 6-1 Permanent current assets Capital assets Time period Limited 2000
5 Figure 6-2a Sales and earnings for, PPT $ thousands rd 90 3rd 91 3rd 92 Sources: Symbol: MHR 3rd 93 3rd 94 3rd 95 Quarterly sales 3rd 96 3rd 97 3rd 98 Limited 2000
6 Figure 6-2b Sales and earnings for, PPT $ thousands rd 90 3rd 91 3rd 92 3rd 93 3rd 94 3rd 95 3rd 96 3rd 97 3rd Sources: Symbol: MHR Quarterly earnings Limited 2000
7 Figure 6-3a Sales and earnings for Hudson s Bay Co. and Sears Canada PPT $ millions Sales Sources: Symbol: HBC Symbol: SCC Hudson's Bay Sears Limited 2000
8 Figure 6-3b Sales and earnings for Hudson s Bay Co. and Sears Canada PPT $ thousands Earnings Sources: Symbol: HBC Symbol: SCC Hudson's Bay Sears Limited 2000
9 Expanded cash flow cycle PPT 6-3 Customers Inventory Finished Goods Goods in in process Raw Raw materials Materials and and service Suppliers: accts. accts. payable Labor: wages payable Other: expenses Sales Sales Geographical area area Product or or division Customer type type Cash Accounts receivable days days days days days days days days Marketable securities Interest and dividends Government taxes taxes Federal income taxes taxes Provincial taxes taxes Other Other taxes taxes -term lenders Chartered banks banks Non-bank lenders Foreign banks banks and and lenders Limited 2000
10 Table 6-1 Yawakuzi sales forecast (in units) PPT 6-4 1st Quarter 2nd Quarter 3rd Quarter Quarter October. 300 January.. 0 April.1,000 July. 2,000 November..150 February. 0 May..2,000 August.1,000 December March June..2,000 September..500 Total sales of 9,600 units at $3,000 each = $28,800,000 in sales. Limited 2000
11 Table 6-2 Yawakuzi s production schedule and inventory PPT 6-5 Inventory Production (at cost of Beginning (level Ending $2,000 inventory + production) Sales = inventory per unit) October ,300 $2,600,000 November 1, ,950 3,900,000 December 1, ,700 5,400,000 January 2, ,500 7,000,000 February 3, ,300 8,600,000 March 4, ,500 9,000,000 April 4, ,000 4,300 8,600,000 May 4, ,000 3,100 6,200,000 June 3, ,000 1,900 3,800,000 July 1, , ,400,000 August , ,000,000 September ,600,000 Limited 2000
12 Table 6-3a Sales forecast, cash receipts and payments, and cash budget PPT 6-6 Oct Nov Dec Jan Feb Mar Apr May June July Aug Sept Sales Forecast ($ millions) Sales (units) ,000 2,000 2,000 2,000 1, Sales $0.9 $0.45 $0.15 $1.8 $3.0 $6.0 $6.0 $6.0 $3.0 $1.5 (unit price, $3,000) 50% cash.45 $.225 $.075 $0.9 $1.5 $3.0 $3.0 $3.0 $1.5 $.75 50% cash from prior month s sales.75* Total cash receipts $ $0.300 $0.075 $0.9 $2.4 $4.5 $6.0 $6.0 $4.5 $2.25 *Assumes September sales of $1.5 million. Cash Receipts Schedule ($ millions) Limited 2000
13 Table 6-3b Sales forecast, cash receipts and payments, and cash budget Oct Nov Dec Jan Feb Mar Apr May June July Aug Sept Cash Payments Schedule ($ millions) PPT 6-6 Constant production of 800 units/month (cost $2,000 per unit) $1.6 $1.6 $1.6 $1.6 $1.6 $1.6 $1.6 $1.6 $1.6 $1.6 $1.6 $1.6 Overhead Dividends & interest 1.0 Taxes Total cash payments $2.3 $2.0 $2.0 $2.3 $2.0 $2.0 $2.3 $2.0 $2.0 $2.3 $3.0 $2.0 Cash Budget ($ millions; required minimum balance is $0.25 million) Cash flow $(1.1) $(1.325) $(1.7) $(2.225) $(2.0) $(1.1) $.1 $2.5 $4.0 $3.7 $1.5 $.25 Beginning cash Cumulative cash balance $(.85)$(1.075) $(1.45) $(1.975) $(1.75) $(.85) $.35 $2.75 $4.25 $3.95 $2.6 $2.85 Monthly loan or (repayment) (0.1) (2.5) (4.0) (2.85) Cumulative loan Ending cash balance Assumes cash balance of $.25 million at the beginning of October and that this is the desired minimum cash balance. Limited 2000
14 Table 6-4 Total current assets, first year ($ millions) PPT 6-7 Accounts Total Current Cash Receivable Inventory Assets October $0.25 $0.450 $2.6 $3.30 November December January February March April May June July August September Limited 2000
15 End of First Year Second Year PPT 6-8 Table 6-5a Cash budget and assets for second year with no growth in sales ($ millions) Sept Oct Nov Dec Jan Feb Mar Apr May June July Aug Sept Cash flow $0.25 $(1.1) $(1.325) $(1.7) $(2.225 $(2.0) $(1.1) $0.1 $2.5 $4.0 $3.7 $1.5 $0.25 Beginning cash Cumulative (1.275) (1.975) (1.75) (0.85) cash balance Monthly loan or (repayment) (0.1) (2.5) (4.0) (0.25) Cumulative loan Ending cash balance $2.85 $1.75 $0.425 $0.25 $0.25 $0.25 $0.25 $0.25 $0.25 $0.25 $3.70 $5.2 $5.45 Limited 2000
16 End of First Year Second Year Sept Oct Nov Dec Jan Feb Mar Apr May June July Aug Sept Total Current Assets PPT 6-8 Table 6-5b Cash budget and assets for second year with no growth in sales ($ millions) Ending cash balance $2.85 $1.75 $0.425 $0.25 $0.25 $0.25 $0.25 $0.25 $0.25 $0.25 $3.70 $5.2 $5.45 Accounts receivable Inventory Total current assets $5.2 $4.8 $4.55 $5.725 $7.25 $8.85 $10.15 $10.35 $9.45$7.05 $8.1 $7.7 $7.80 Limited 2000
17 Figure 6-6 The nature of asset growth (Yawakuzi) 11 $ millions PPT Accounts receivable Total current assets Inventory Cash Inventory O N D J F M A M J J A S O N D J F M A M J J A S Cash Accounts receivable Inventory Limited 2000
18 Figure 6-7 Matching long-term and short-term needs Dollars Temporary current assets PPT term financing Permanent current assets Long-term financing Capital assets (debt & equity) Time period Limited 2000
19 Figure 6-8 Using long-term financing for part of short-term needs PPT 6-11 Dollars Temporary current assets -term financing Permanent current assets Long-term financing (debt & equity) Capital assets Time period Limited 2000
20 Figure 6-9 Using short-term financing for part of long-term needs PPT 6-11 Dollars Temporary current assets -term financing Permanent current assets Long-term financing Capital assets (debt & equity) Time period Limited 2000
21 Figure 6-11 A. Flat yield curve, March 1999 PPT 6-12 Percent Years Limited 2000
22 Figure 6-11(2) A. Normal yield curve, July 1993 PPT 6-12 Limited 2000
23 Figure 6-11(3) C. Inverted yield curve, December 1989 PPT 6-12 Limited 2000
24 Figure 6-12 Long-term and short-term interest rates PPT 6-13 Limited 2000
25 Table 6-7 Alternative financing plans EDWARDS CORPORATION Plan A Plan B Part 1. Current assets Temporary $250,000 $250,000 Permanent , ,000 Total current assets , ,000 -term financing (6%).. 500, ,000 Long-term financing (10%) ,000 $500,000 $500,000 Part 2. Capital assets Plant and equipment.... $100,000 $100,000 Long-term financing (10%). $100,000 $100,000 PPT 6-14 Part 3. Total financing (summary of parts 1 & 2) -term (6%)..... $500,000 $150,000 Long-term (10% , ,000 $600,000 $600,000 Limited 2000
26 Table 6-8 Impact of financing plans on earnings EDWARDS CORPORATION Plan A Earnings before interest and taxes $200,000 Interest (short-term), 6% $500,000 30,000 Interest (long-term), 10% $100,000 10,000 Earnings before taxes 160,000 Taxes (50%) 80,000 Earnings aftertaxes $ 80,000 Plan B Earnings before interest and taxes $200,000 Interest (short-term), 6% $150,000 9,000 Interest (long-term), 10% $450,000 45,000 Earnings before taxes 146,000 Taxes (50%) 73,000 Earnings aftertaxes $ 73,000 PPT 6-14 Limited 2000
27 Table 6-9 Expected returns under different economic conditions EDWARDS CORPORATION PPT Normal Expected higher return Probability of Expected conditions under Plan A normal conditions outcome $7, = + $5, Tight Expected lower return Probability of money under Plan A tight money ($15,000).20 = (3,000) Expected value of return for Plan A versus Plan B = +$2,600 Limited 2000
28 Table 6-10 Expected returns for high-risk firm PPT 6-15 EDWARDS CORPORATION 1. Normal Expected higher return Probability of Expected conditions under Plan A normal conditions outcome $7, = +$5, Tight Expected lower return Probability of money under Plan A tight money ($50,000).20 = (10,000) Expected value of return for Plan A versus Plan B = ($4,400) Limited 2000
29 Table 6-11 Current asset liquidity and asset financing plan PPT 6-16 Asset Liquidity Financing Plan Low Liquidity High Liquidity 1 2 -term High Profit Moderate profit High risk Moderate risk 3 4 Long-term Moderate profit Low profit Moderate risk Low risk Limited 2000
30 Chapter 6 - Outline LT 6-1 What is Working Capital? Hedged Approach to Financing -Term vs. Long-Term Financing Term Structure of Interest Rates Working Capital Financing Plans Limited 2000
31 Working Capital LT 6-2 Working Capital is financing and controlling the current assets of a firm Sales growth often leads to a buildup in inventory and accounts receivable. Firm may require additional external financing Crucial to short-term success or failure of a business Limited 2000
32 Hedged Approach to Financing LT 6-3 Match liquidity (life) of your assets to the maturity (term) of your financing Means your assets will be generating cash when your liabilities come due Balanced Financing Temporary (seasonal) build-up in inventory and accounts receivable finance with trade credit, short-term bank loans, short-term notes payable Permanent (minimum) levels of inventory, receivables + Property and equipment, long-term investments finance with long-term loans, leases, bonds, capital stock, retained earnings Limited 2000
33 -Term vs. Long-Term Financing LT 6-4 -term financing is less expensive but riskier lower interest rates short-term rates are volatile risk of default if sales slow down risk that bank may not extend / renew loans Long-term financing is more expensive but less risky usually higher interest rates, you may pay interest on funds you don t always need you have capital at all times Firm must decide the appropriate mix Limited 2000
34 Term Structure of Interest Rates LT 6-5 The Term Structure of Interest Rates is also known as the Yield Curve A graph showing the interest rate for Government of Canada securities with different maturity dates Normally, long-term rates are higher than short-term rates Limited 2000
35 Working Capital Financing Plans LT 6-6 A moderate (balanced) firm: S/T financing and high liquidity OR L/T financing and low liquidity An aggressive (risky) firm: S/T financing and low liquidity A conservative (safe or cautious) firm: L/T financing and high liquidity Appropriate strategy is determined based on company s tolerance for risk Limited 2000
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