Chapter 19 Fundamentals of Corporate Finance Fifth Edition Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved Short-Term Financial Planning

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 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

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin Firm’s Cumulative Capital Requirement 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 A B C Year 2Year 1 Dollars Cumulative capital requirement Time

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 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.

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin Working Capital Simple Cycle of operations Cash Finished goods inventory Receivables Raw materials inventory

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin Working Capital

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin Working Capital Example - Cash Conversion Cycle Given the aggregate balance sheet and income statement for US Manufacturing firms, calculate the cash conversion cycle.

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin Working Capital Example - Cash Conversion Cycle Given the aggregate balance sheet and income statement for US Manufacturing firms, calculate the cash conversion cycle.

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin Working Capital Example - Cash Conversion Cycle Given the aggregate balance sheet and income statement for US Manufacturing firms, calculate the cash conversion cycle.

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin Working Capital Example - Cash Conversion Cycle Given the aggregate balance sheet and income statement for US Manufacturing firms, calculate the cash conversion cycle.

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin Working Capital Example - Cash Conversion Cycle Given the aggregate balance sheet and income statement for US Manufacturing firms, calculate the cash conversion cycle.

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin Changes in Cash & W.C. Example - Dynamic Mattress Company

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin Changes in Cash & W.C. Example - Dynamic Mattress Company Assume dividend = $1 mil R.E.=$11 mil

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin Changes in Cash & W.C. Example - Dynamic Mattress Company

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 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

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 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.

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin Cash Budgeting Example - Dynamic Mattress Company Dynamic forecasted sources of cash AR ending balance = AR beginning balance + sales - collections

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin Cash Budgeting Example - Dynamic Mattress Company Dynamic collections on AR

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 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

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin Cash Budgeting Example - Dynamic Mattress Company Dynamic cash budget

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin Cash Budgeting Example - Dynamic Mattress Company Dynamic short term financing requirements

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin A Short Term Financing Plan Example - Dynamic Mattress Company Dynamic forecasted deferrable expenses

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin A Short Term Financing Plan Example - Dynamic Mattress Company- Financing Plan

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin Sources of Short Term Financing  Bank loans  Commercial paper  Secured loans

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin Cost of Bank Loans Simple Interest Effective annual rate

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin Cost of Bank Loans Discount Interest