1.  2005, Pearson Prentice Hall Chapter 18 – Working-Capital Management and Short-term Financing

2. 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?

3. 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. Current assets earn low returns, but help reduce the risk of illiquidity.

4. 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?

5. 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. Current liabilities are less expensive, but increase the risk of illiquidity.

6. Balance Sheet Current Assets Current Liabilities Current Assets Current Liabilities Fixed Assets Long-Term Debt Fixed Assets Long-Term Debt Preferred Stock Preferred Stock Common Stock Common Stock To illustrate, let’s finance all current assets with current liabilities,

7. Balance Sheet Current Assets Current Liabilities Current Assets Current Liabilities Fixed Assets Long-Term Debt Fixed Assets Long-Term Debt Preferred Stock Preferred Stock Common Stock Common Stock To illustrate, let’s finance all current assets with current liabilities,

8. Balance Sheet Current Assets Current Liabilities Current Assets Current Liabilities Fixed Assets Long-Term Debt Fixed Assets Long-Term Debt Preferred Stock Preferred Stock Common Stock Common Stock To illustrate, let’s finance all current assets with current liabilities, and finance all fixed assets with long-term financing.

9. Balance Sheet Current Assets Current Liabilities Current Assets Current Liabilities Fixed Assets Long-Term Debt Fixed Assets Long-Term Debt Preferred Stock Preferred Stock Common Stock Common Stock To illustrate, let’s finance all current assets with current liabilities, and finance all fixed assets with long-term financing.

10. Balance Sheet Current Assets Current Liabilities Current Assets Current Liabilities Fixed Assets Long-Term Debt Fixed Assets Long-Term Debt Preferred Stock Preferred Stock Common Stock Common Stock

11. Balance Sheet Current Assets Current Liabilities Current Assets Current Liabilities Fixed Assets Long-Term Debt Fixed Assets Long-Term Debt Preferred Stock Preferred Stock Common Stock Common Stock Suppose we use long-term financing to finance some of our current assets.

12. Balance Sheet Current Assets Current Liabilities Current Assets Current Liabilities Fixed Assets Long-Term Debt Fixed Assets Long-Term Debt Preferred Stock Preferred Stock Common Stock Common Stock Suppose we use long-term financing to finance some of our current assets.

13. Balance Sheet Current Assets Current Liabilities Current Assets Current Liabilities Fixed Assets Long-Term Debt Fixed Assets Long-Term Debt Preferred Stock Preferred Stock Common 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!

14. Balance Sheet Current Assets Current Liabilities Current Assets Current Liabilities Fixed Assets Long-Term Debt Fixed Assets Long-Term Debt Preferred Stock Preferred Stock Common Stock Common Stock

15. Balance Sheet Current Assets Current Liabilities Current Assets Current Liabilities Fixed Assets Long-Term Debt Fixed Assets Long-Term Debt Preferred Stock Preferred Stock Common Stock Common Stock Suppose we use current liabilities to finance some of our fixed assets.

16. Balance Sheet Current Assets Current Liabilities Current Assets Current Liabilities Fixed Assets Long-Term Debt Fixed Assets Long-Term Debt Preferred Stock Preferred Stock Common Stock Common Stock Suppose we use current liabilities to finance some of our fixed assets.

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

18. 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.

19. Balance Sheet Temporary Current Assets

20. Balance Sheet Temporary Temporary Current Assets Short-term financing

21. Balance Sheet Temporary Temporary Current Assets Short-term financing Permanent Fixed Assets

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

23. 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.

24. Cost of Short-Term Credit Interest = principal x rate x time Example: Borrow $10,000 at 8.5% for 9 months. Interest = $10,000 x.085 x 3/4 year = $637.50 = $637.50

25. We can use this simple relationship: Interest = principal x rate x time to solve for rate, and get the Cost of Short-Term Credit

26. We can use this simple relationship: Interest = principal x rate x time to solve for rate, and get the Annual Percentage Rate (APR) Cost of Short-Term Credit

27. APR = x 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 interest 1 principal time principal time Cost of Short-Term Credit

29. APR = x interest 1 interest 1 principal time principal time Cost of Short-Term Credit

30. APR = x interest 1 interest 1 principal time principal time Example: If you pay $637.50 in interest on $10,000 principal for 9 months: Cost of Short-Term Credit

31. APR = x interest 1 interest 1 principal time 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 = 8.5% APR Cost of Short-Term Credit

32. Annual Percentage Yield (APY) is similar to APR, except that it accounts for compound interest: Cost of Short-Term Credit

33. APY = ( 1 + ) - 1 Annual Percentage Yield (APY) is similar to APR, except that it accounts for compound interest: i m i m m Cost of Short-Term Credit

34. APY = ( 1 + ) - 1 Annual Percentage Yield (APY) is similar to APR, except that it accounts for compound interest: i m i m m i = the nominal rate of interest m = the # of compounding periods per year Cost of Short-Term Credit

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

36. Sources of Short-term Credit Unsecured

37. Unsecured  Accrued wages and taxes.

38. Sources of Short-term Credit Unsecured  Accrued wages and taxes.  Trade credit.

39. Sources of Short-term Credit Unsecured  Accrued wages and taxes.  Trade credit.  Bank credit.

40. Sources of Short-term Credit Unsecured  Accrued wages and taxes.  Trade credit.  Bank credit.  Commercial paper.

41. Sources of Short-term Credit Unsecured  Accrued wages and taxes.  Trade credit.  Bank credit.  Commercial paper.  Secured

42. Sources of Short-term Credit Unsecured  Accrued wages and taxes.  Trade credit.  Bank credit.  Commercial paper. Secured  Accounts receivable loans.

43. Sources of Short-term Credit Unsecured  Accrued wages and taxes.  Trade credit.  Bank credit.  Commercial paper. Secured  Accounts receivable loans.  Inventory loans.