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Short Term Financial Planning Principles of Corporate Finance Brealey and Myers Sixth Edition Slides by Matthew Will Chapter 29 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill
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© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 29- 2 Topics Covered Working Capital Links Between Long-Term and Short-Term Financing Tracing Changes in Cash and Working Capital Cash Budgeting A Short-Term Financing Plan
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© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 29- 3 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.
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© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 29- 4 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
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© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 29- 5 Working Capital Simple Cycle of operations Cash
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© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 29- 6 Working Capital Simple Cycle of operations Cash Raw materials inventory
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© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 29- 7 Working Capital Simple Cycle of operations Cash Finished goods inventory Raw materials inventory
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© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 29- 8 Working Capital Simple Cycle of operations Cash Finished goods inventory Receivables Raw materials inventory
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© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 29- 9 Working Capital Simple Cycle of operations Cash Finished goods inventory Receivables Raw materials inventory
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© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 29- 10 Changes in Cash & W.C. Example - Dynamic Mattress Company
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© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 29- 11 Changes in Cash & W.C. Example - Dynamic Mattress Company Assume dividend = $1 mil R.E.=$11 mil
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© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 29- 12 Changes in Cash & W.C. Example - Dynamic Mattress Company
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© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 29- 13 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.
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© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 29- 14 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.
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© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 29- 15 Cash Budgeting Example - Dynamic Mattress Company Dynamic forecasted sources of cash AR ending balance = AR beginning balance + sales - collections
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© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 29- 16 Cash Budgeting Example - Dynamic Mattress Company Dynamic collections on AR
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© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 29- 17 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
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© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 29- 18 Cash Budgeting Example - Dynamic Mattress Company Dynamic cash budget
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© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 29- 19 Cash Budgeting Example - Dynamic Mattress Company Dynamic short term financing requirements
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© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 29- 20 A Short Term Financing Plan Example - Dynamic Mattress Company Dynamic forecasted deferrable expenses
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© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 29- 21 A Short Term Financing Plan Example - Dynamic Mattress Company- Financing Plan
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