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, Prentice Hall, Inc.
Ch. 18:
Management
and Short-Term Financing
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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 Assets– cash, marketable securities, inventory,
accounts receivable
• Long-Term Assets– equipment, buildings, land
• Risk-Return Trade-off: Current assets earn low returns, but
help reduce the 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 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
• Risk-Return Trade-off: Current liabilities are less expensive,
but increase the risk of illiquidity.
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Balance Sheet
Current Assets Current Liabilities
Fixed Assets Long-Term Debt
Preferred Stock
Common Stock
To illustrate, let’s finance all current assets with current liabilities,
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Balance Sheet
Current Assets Current Liabilities
Fixed Assets Long-Term Debt
Preferred Stock
Common Stock
To illustrate, let’s finance all current assets with current liabilities,
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Balance Sheet
Current Assets Current Liabilities
Fixed Assets Long-Term Debt
Preferred Stock
Common Stock
To illustrate, let’s finance all current assets with current liabilities, and finance all fixed assets with long-term financing.
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Balance Sheet
Current Assets Current Liabilities
Fixed Assets Long-Term Debt
Preferred Stock
Common Stock
To illustrate, let’s finance all current assets with current liabilities, and finance all fixed assets with long-term financing.
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Balance Sheet
Current Assets Current Liabilities
Fixed Assets Long-Term Debt
Preferred Stock
Common Stock
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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.
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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.
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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
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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.
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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.
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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 > 1 year)– should be financed with permanent and
spontaneous sources of financing.
• Temporary Assets (those held < 1 year)– should be financed with temporary
sources of financing.
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Balance Sheet
Temporary
Current Assets
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Balance Sheet
Temporary Temporary
Current Assets Short-term financing
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Balance Sheet
Temporary Temporary
Current Assets Short-term financing
Permanent
Fixed Assets
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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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We can use this simple relationship:
Interest = principal x rate x timeto solve for rate, and get the
Cost of Short-Term Credit
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We can use this simple relationship:
Interest = principal x rate x timeto solve for rate, and get the
Annual Percentage Rate (APR)
Cost of Short-Term Credit
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APR = x
We can use this simple relationship:
Interest = principal x rate x timeto solve for rate, and get the
Annual Percentage Rate (APR)
interest 1
principal time
Cost of Short-Term Credit
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Cost of Short-Term Credit
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APR = x interest 1
principal time
Cost of Short-Term Credit
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APR = x interest 1
principal time
example: If you pay $637.50 in interest on $10,000 principal for 9 months:
Cost of Short-Term Credit
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APR = x 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
Cost of Short-Term Credit
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Annual Percentage Yield (APY) is similar to APR, except that it accounts for compound interest:
Cost of Short-Term Credit
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APY = ( 1 + ) - 1
Annual Percentage Yield (APY) is similar to APR, except that it accounts for compound interest:
i m
m
Cost of Short-Term Credit
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APY = ( 1 + ) - 1
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
Cost of Short-Term Credit
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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
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Sources of Short-term Credit
• Unsecured– accrued wages and taxes
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Sources of Short-term Credit
• Unsecured– accrued wages and taxes
– trade credit
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Sources of Short-term Credit
• Unsecured– accrued wages and taxes
– trade credit
– bank credit
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Sources of Short-term Credit
• Unsecured– accrued wages and taxes
– trade credit
– bank credit
– commercial paper
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Sources of Short-term Credit
• Unsecured– accrued wages and taxes
– trade credit
– bank credit
– commercial paper
• Secured
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Sources of Short-term Credit
• Unsecured– accrued wages and taxes
– trade credit
– bank credit
– commercial paper
• Secured– accounts receivable loans
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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