Fundamentals of corporate finance 5e mcgraw chapter 019

Fundamentals of Corporate Finance Chapter 19 Short-Term Financial Planning Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- Topics Covered Links Between Long-Term and Short-Term Financing Working Capital Tracing Changes in Cash and Working Capital Cash Budgeting A Short-Term Financing Plan Sources of Short-Term Financing The Cost of Bank Loans McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- Firm’s Cumulative Capital Requirement Dollars A B C Cumulative capital requirement Year Year Time Lines A, B, and C show alternative amounts of long-term finance Strategy A: A permanent cash surplus Strategy B: Short-term lender for part of year and borrower for remainder Strategy C: A permanent short-term borrower McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- Working Capital Net Working Capital - Current assets minus current liabilities Often called working capital Cash Conversion Cycle - Period between firm’s payment for materials and collection on its sales Carrying Costs - Costs of maintaining current assets, including opportunity cost of capital Shortage Costs - Costs incurred from shortages in current assets McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- Working Capital Simple Cycle of operations Cash Raw materials inventory Receivables Finished goods inventory McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- Working Capital average inventory Inventory period = annual COGS / 365 average accounts receivable Receivables period = annual sales / 365 average accounts payable Payable period = annual COGS / 365 McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- Working Capital Example - Cash Conversion Cycle Given the aggregate balance sheet and income statement for US Manufacturing firms, calculate the cash conversion cycle Income Statement Balance 3rdQtr '04 Sheet End 4th qtr '03 End of 4th qtr '04 Sales 4,951 Inventory 453 490 COGS 4,451 A/R 500 552 A/P 335 382 McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- Working Capital Example - Cash Conversion Cycle Given the aggregate balance sheet and income statement for US Manufacturing firms, calculate the cash conversion cycle average inventory Inventory period = annual COGS/365 (490 + 453)/2 = 4,451/365 = 38.7 days McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- Working Capital Example - Cash Conversion Cycle Given the aggregate balance sheet and income statement for US Manufacturing firms, calculate the cash conversion cycle average accounts receivable Receivable s period = annual sales/365 = (552 + 500)/2 4,951/365 = 38.8 days McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- 10 Working Capital Example - Cash Conversion Cycle Given the aggregate balance sheet and income statement for US Manufacturing firms, calculate the cash conversion cycle average accounts payable Payable period = annual COGS/365 (382 + 335)/2 = 4,451 / 365 = 29.4 days McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- 12 Changes in Cash & W.C Example - Dynamic Mattress Company Assets Current Assets Cash Mark Securities Inventory Accts Recv Total Curr Assets Fixed Assets Gross investment less Depr Net Fixed Assets Total Assets McGraw-Hill/Irwin 2005 4 2006 5 26 25 55 25 30 65 56 16 40 95 70 20 50 115 Liabilities & Equity 2005 Current Liabilities Bank Loans 2006 Accts Payable Total Curr Liab Long Term Debt Net Worth 20 25 65 27 27 12 76 Total Liab and owner' s equity 95 115 Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- 13 Changes in Cash & W.C Example - Dynamic Mattress Company Income Statement Sales $350 Operating Costs Depreciation EBIT dividend = $1 mil R.E.=$11 mil 25 Interest McGraw-Hill/Irwin 321 Assume Pretax income 24 Tax at 50% 12 Net Income $12 Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- 14 Changes in Cash & W.C Example Dynamic Mattress Company McGraw-Hill/Irwin Sources Issued long term debt Reduced inventories Increased accounts payable Cash from operations Net income 12 Depreciation Total Sources $31 Uses Repaid short term bank loan Invested in fixed assets 14 Purchased marketable securities Increased accounts receivable Dividend Total Uses $30 Increase in cash balance $1 Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- 15 Changes in Cash & W.C Example - Dynamic Mattress Company Dynamic used cash as follows  Paid $1 mil dividend  Repaid $5 mil short term bank loan  Invested $14 mil  Purchased $5 mil of marketable securities  Accounts receivable expanded by $5 mil McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- 16 Cash Budgeting Steps to preparing a cash budget Step - Forecast the sources of cash Step - Forecast uses of cash Step - Calculate whether the firm is facing a cash shortage or surplus McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- 17 Cash Budgeting Example - Dynamic Mattress Company Dynamic forecasted sources of cash Quarter Sales, $mil 1st 2nd 3rd 4th 87.50 78.50 116.00 131.00 AR ending balance = AR beginning balance + sales collections McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- 18 Cash Budgeting Example - Dynamic Mattress Company Dynamic collections on AR Qtr 1st 30.0 87.5 Beginning receivables Sales Collections Sales in current Qtr (80%) 70 Sales in previous Qtr (20%) 15.0 Total collections 85.0 Receivables at end of period (4 = + - 3) $32.5 McGraw-Hill/Irwin 2nd 3rd 4th 32.5 30.7 38.2 78.5 116.0 131.0 62.8 17.5 80.3 92.8 15.7 108.5 104.8 23.2 128.0 $30.7 $38.2 $41.2 Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- 19 Cash Budgeting Example - Dynamic Mattress Company Dynamic forecasted uses of cash  Payment of accounts payable  Labor, administration, and other expenses  Capital expenditures  Taxes, interest, and dividend payments McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- 20 Cash Budgeting Example - Dynamic Mattress Company Dynamic cash budget Qtr 1st 2nd 3rd 4th 85.0 80.3 108.5 128.0 1.5 0.0 12.5 0.0 86.5 80.3 121.0 128.0 payment of AP 65.0 60.0 55.0 50.0 labor and admin expenses 30.0 30.0 30.0 30.0 capital expenditures 32.5 1.3 5.5 8.0 4.0 4.0 4.5 5.0 Total uses of cash 131.5 95.3 95.0 93.0 Net cash inflow (sources minus uses) $45.0 $15.0 $26.0 $35.0 Sources of cash collections on AR other Total Sources Uses of cash taxes, interest, & dividends McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- 21 Cash Budgeting Example - Dynamic Mattress Company Dynamic short term financing requirements Cash at start of period - 40 - 55 - 29 + Net cash flow - 45 - 15 + 26 + 35 = Cash at end of period - 40 - 55 - 29 + 5 5 $45 $60 $34 - $1 Min operating cash balance Cumulative short term financing required (minimum cash balance minus caash at end of period) McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- 22 A Short Term Financing Plan Example - Dynamic Mattress Company Dynamic forecasted deferrable expenses Quarter 1st 2nd 3rd 4th Amount Deferrable, $mil 52 48 144 40 McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- 23 A Short Term Financing Plan Qtr Example Dynamic Mattress CompanyFinancing Plan McGraw-Hill/Irwin 1st 2nd 3rd 4th 45 15 - 26 - 35 Interest on bank loan Interest on stretechd payables 8 Total cash required Cash Raised 45 15.8 - 24.4 - 34.4 Bank loan Stretched payables Securities sold 40 0 15.8 0 0 0 Total cash raised Repayments 45 15.8 0 Of stretched payables 10 Of line of credit 0 0 15.8 8.6 31.4 Increase in cash balances 11 Addition to cash balances Line of credit 0 12 Beginning of quarter 13 End of quarter 40 40 40 40 31.4 31.4 Cash Requirements Cash for operations Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- 24 Sources of Short Term Financing Bank loans Commercial paper Secured loans McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- 25 Cost of Bank Loans Simple Interest annual interest rate Amount of loan X number of periods in the year Effective annual rate (1 + McGraw-Hill/Irwin quoted annual interest rate n ) n -1 Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 19- 26 Cost of Bank Loans Discount Interest ( Face value of loan X - McGraw-Hill/Irwin quoted annual interest rate number of periods in the year Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved ) [...]... interest rate Amount of loan X number of periods in the year Effective annual rate (1 + McGraw- Hill/Irwin quoted annual interest rate n ) n -1 Copyright © 2007 by The McGraw- Hill Companies, Inc All rights reserved 19- 26 Cost of Bank Loans Discount Interest ( Face value of loan X 1 - McGraw- Hill/Irwin quoted annual interest rate number of periods in the year Copyright © 2007 by The McGraw- Hill Companies,... balances Line of credit 0 0 0 3 12 Beginning of quarter 13 End of quarter 0 40 40 40 40 31.4 31.4 0 Cash Requirements 1 Cash for operations Copyright © 2007 by The McGraw- Hill Companies, Inc All rights reserved 19- 24 Sources of Short Term Financing Bank loans Commercial paper Secured loans McGraw- Hill/Irwin Copyright © 2007 by The McGraw- Hill Companies, Inc All rights reserved 19- 25 Cost of Bank Loans... mil of marketable securities  Accounts receivable expanded by $5 mil McGraw- Hill/Irwin Copyright © 2007 by The McGraw- Hill Companies, Inc All rights reserved 19- 16 Cash Budgeting Steps to preparing a cash budget Step 1 - Forecast the sources of cash Step 2 - Forecast uses of cash Step 3 - Calculate whether the firm is facing a cash shortage or surplus McGraw- Hill/Irwin Copyright © 2007 by The McGraw- Hill... $26.0 $35.0 Sources of cash collections on AR other Total Sources Uses of cash taxes, interest, & dividends McGraw- Hill/Irwin Copyright © 2007 by The McGraw- Hill Companies, Inc All rights reserved 19- 21 Cash Budgeting Example - Dynamic Mattress Company Dynamic short term financing requirements Cash at start of period 5 - 40 - 55 - 29 + Net cash flow - 45 - 15 + 26 + 35 = Cash at end of period - 40 -... collections 85.0 4 Receivables at end of period (4 = 1 + 2 - 3) $32.5 McGraw- Hill/Irwin 2nd 3rd 4th 32.5 30.7 38.2 78.5 116.0 131.0 62.8 17.5 80.3 92.8 15.7 108.5 104.8 23.2 128.0 $30.7 $38.2 $41.2 Copyright © 2007 by The McGraw- Hill Companies, Inc All rights reserved 19- 19 Cash Budgeting Example - Dynamic Mattress Company Dynamic forecasted uses of cash  Payment of accounts payable  Labor, administration,... required (minimum cash balance minus caash at end of period) McGraw- Hill/Irwin Copyright © 2007 by The McGraw- Hill Companies, Inc All rights reserved 19- 22 A Short Term Financing Plan Example - Dynamic Mattress Company Dynamic forecasted deferrable expenses Quarter 1st 2nd 3rd 4th Amount Deferrable, $mil 52 48 144 40 McGraw- Hill/Irwin Copyright © 2007 by The McGraw- Hill Companies, Inc All rights reserved... payments McGraw- Hill/Irwin Copyright © 2007 by The McGraw- Hill Companies, Inc All rights reserved 19- 20 Cash Budgeting Example - Dynamic Mattress Company Dynamic cash budget Qtr 1st 2nd 3rd 4th 85.0 80.3 108.5 128.0 1.5 0.0 12.5 0.0 86.5 80.3 121.0 128.0 payment of AP 65.0 60.0 55.0 50.0 labor and admin expenses 30.0 30.0 30.0 30.0 capital expenditures 32.5 1.3 5.5 8.0 4.0 4.0 4.5 5.0 Total uses of cash... Dynamic Mattress CompanyFinancing Plan McGraw- Hill/Irwin 1st 2nd 3rd 4th 45 15 - 26 - 35 2 Interest on bank loan 0 3 Interest on stretechd payables 0 8 0 8 8 6 0 4 Total cash required Cash Raised 45 15.8 - 24.4 - 34.4 5 Bank loan 6 Stretched payables 7 Securities sold 40 0 5 0 0 15.8 0 0 0 0 0 0 8 Total cash raised Repayments 45 15.8 0 0 9 Of stretched payables 10 Of line of credit 0 0 0 0 15.8 8.6 0 31.4... Receivables period = 38.8 days Payable period = 29.4 days McGraw- Hill/Irwin Copyright © 2007 by The McGraw- Hill Companies, Inc All rights reserved 19- 12 Changes in Cash & W.C Example - Dynamic Mattress Company Assets Current Assets Cash Mark Securities Inventory Accts Recv Total Curr Assets Fixed Assets Gross investment less Depr Net Fixed Assets Total Assets McGraw- Hill/Irwin 2005 4 4 2006 5 5 0 26 25 55 5... Companies, Inc All rights reserved 19- 17 Cash Budgeting Example - Dynamic Mattress Company Dynamic forecasted sources of cash Quarter Sales, $mil 1st 2nd 3rd 4th 87.50 78.50 116.00 131.00 AR ending balance = AR beginning balance + sales collections McGraw- Hill/Irwin Copyright © 2007 by The McGraw- Hill Companies, Inc All rights reserved 19- 18 Cash Budgeting Example - Dynamic Mattress Company Dynamic collections