FINA 2201 Chapter Notes - Chapter 16: Cash Conversion Cycle, Working Capital, Accounts Payable

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periwinkledinosaur391

4 Apr 2016

School

Northeastern University

Department

Finance & Insurance

Course

FINA 2201

Professor

Mazur Jack

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Document Summary

Fina chapter 16 working capital management: working capital. The top line has the steepest slope, which indicates that the firm holds a great deal of cash, marketable securities, receivables, and inventories relative to its sales. When receivables are high, the firm has a liberal credit policy, which results in a high level of accounts receivable. On the other hand, when a firm has a restricted investment policy (or tight or lean-and-mean ) investment policy, holdings of current assets are minimized. A moderate investment policy lies between the two extremes. A restricted (lean-and-mean) policy indicates a low level of assets (hence, a high total assets turnover ratio), which results in a high roe, other things held constant. However, this policy also exposes the firm to risks because shortages can lead to work stoppages, unhappy customers, and serious long-run problems. The relaxed policy minimizes such operating problems, but it results in a low turnover, which in turn lowers roe.

Related Questions

Change in net working capital calculationâââSamuels Manufacturing is considering the purchase of a new machine to replace one it believes is obsolete. The firm has total current assets of $930,000 and total current liabilities of $644,000.

As a result of the proposedâ replacement, the following changes are anticipated in the levels of the current asset and current liability accounts noted.

Account	Change
Accruals	+$43,000
Marketable securities	0
Inventories	-11,000
Accounts payable	+86,000
Notes payable	0
Accounts receivable	+148,000
Cash	+12,000

a. Using the informationâ given, calculate any change in net working capital that is expected to result from the proposed replacement action.

b. Explain why a change in these current accounts would be relevant in determining the initial investment for the proposed capital expenditure.

c. Would the change in net working capital enter into any of the other cash flow components that make up the relevant cashâ flows? Explain.

burgundycrab42

The 2015 financial statements for Growth Industries are presented below:

INCOME STATEMENT, 2015
Sales		$	370,000
Costs			235,000

EBIT		$	135,000
Interest expense			27,000

Taxable income		$	108,000
Taxes (at 35%)			37,800

Net income		$	70,200

Dividends	$ 42,120
Addition to retained earnings	28,080

BALANCE SHEET, YEAR-END, 2015
Assets			Liabilities
Current assets			Current liabilities
Cash	$	6,000	Accounts payable	$	13,000

Accounts receivable		11,000	Total current liabilities	$	13,000
Inventories		33,000	Long-term debt		270,000

Total current assets	$	50,000	Stockholdersâ equity
Net plant and equipment		310,000	Common stock plus additional paid-in capital		15,000
			Retained earnings		62,000

Total assets	$	360,000	Total liabilities and stockholdersâ equity	$	360,000

Sales and costs in 2016 are projected to be 20% higher than in 2015. Both current assets and accounts payable are projected to rise in proportion to sales. The fixed assets of Growth Industries are operating at only 75% of capacity. Interest expense in 2016 will equal 10% of long-term debt outstanding at the start of the year. The firm will maintain a dividend payout ratio of .60.

What is the required external financing over the next year?

Even if sales increase by 20%, the firm still has more than enough fixed assets to meet production. Only working capital will increase. Net working capital of the firm in 2015 was $. The increase in net working capital will be $, which is less than the increase in the retained earnings. Thus required external financing is $. A negative external financing value indicates the firm will generate more cash than it needs to finance the projected growth. This extra cash can be used to reduce debt, repurchase shares, increase cash reserves, or fund future growth. This extra cash was primarily due to the firm's excess production capacity.

The 2015 financial statements for Growth Industries are presented below:

INCOME STATEMENT, 2015
Sales		$	250,000
Costs			175,000

EBIT		$	75,000
Interest expense			15,000

Taxable income		$	60,000
Taxes (at 35%)			21,000

Net income		$	39,000

Dividends	$ 23,400
Addition to retained earnings	15,600

BALANCE SHEET, YEAR-END, 2015
Assets			Liabilities
Current assets			Current liabilities
Cash	$	8,000	Accounts payable	$	15,000

Accounts receivable		13,000	Total current liabilities	$	15,000
Inventories		29,000	Long-term debt		150,000

Total current assets	$	50,000	Stockholdersâ equity
Net plant and equipment		190,000	Common stock plus additional paid-in capital		15,000
			Retained earnings		60,000

Total assets	$	240,000	Total liabilities and stockholdersâ equity	$	240,000

Sales and costs in 2016 are projected to be 40% higher than in 2015. Both current assets and accounts payable are projected to rise in proportion to sales. The fixed assets of Growth Industries are operating at only 70% of capacity. Interest expense in 2016 will equal 10% of long-term debt outstanding at the start of the year. The firm will maintain a dividend payout ratio of .60.

What is the required external financing over the next year?

Answer:

Even if sales increase by 40%, the firm still has more than enough fixed assets to meet production. Only working capital will increase. Net working capital of the firm in 2015 was $_______ . The increase in net working capital will be $________ , which is less than the increase in the retained earnings. Thus required external financing is $________ . A negative external financing value indicates the firm will generate more cash than it needs to finance the projected growth. This extra cash can be used to reduce debt, repurchase shares, increase cash reserves, or fund future growth. This extra cash was primarily due to the firm's excess production capacity.

FINA 2201 Chapter Notes - Chapter 16: Cash Conversion Cycle, Working Capital, Accounts Payable

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