Chapter Answer
Chapter 16
Working Capital Management
Learning Objectives
After reading this chapter, students should be able to:
◆ Define basic working capital terminology.
◆ Calculate the inventory conversion period, the receivables collection period, and the payables deferral period to determine the cash conversion cycle.
◆ Distinguish among relaxed, restricted, and moderate current asset investment policies, and explain the effect of each on risk and expected return.
◆ Identify and distinguish among the three different current asset financing policies.
◆ Construct a cash budget, and explain its purpose.
◆ Identify two meanings for cash, and explain why firms are likely to hold marketable securities.
◆ List the four elements of a firm’s credit policy, and briefly explain how one would monitor a firm’s accounts receivable by calculating its DSO and reviewing its aging schedule.
◆ Distinguish between free and costly trade credit, calculate both the nominal and effective annual percentage costs of not taking discounts, given specific credit terms, and explain what stretching accounts payable is and how it reduces the cost of trade credit.
◆ Discuss some of the key features of bank loans and calculate simple and “add-on” interest.
◆ Explain why large, financially strong corporations issue commercial paper.
◆ Explain what accruals (accrued liabilities) are, and what is meant by the term “spontaneous funds.”
◆ Define what a “secured” loan is, and what type of collateral can be used to secure a loan.
Lecture Suggestions
We have never found working capital an interesting topic to students, hence it is, to us, a somewhat more difficult subject to teach than most. Perhaps that’s because it comes near the end of the course, when everyone is tired. More likely, though, the problem is that working capital management is really more a matter of operating efficiently than thinking conceptually correctly—i.e., it
Working Capital Management
Learning Objectives
After reading this chapter, students should be able to:
◆ Define basic working capital terminology.
◆ Calculate the inventory conversion period, the receivables collection period, and the payables deferral period to determine the cash conversion cycle.
◆ Distinguish among relaxed, restricted, and moderate current asset investment policies, and explain the effect of each on risk and expected return.
◆ Identify and distinguish among the three different current asset financing policies.
◆ Construct a cash budget, and explain its purpose.
◆ Identify two meanings for cash, and explain why firms are likely to hold marketable securities.
◆ List the four elements of a firm’s credit policy, and briefly explain how one would monitor a firm’s accounts receivable by calculating its DSO and reviewing its aging schedule.
◆ Distinguish between free and costly trade credit, calculate both the nominal and effective annual percentage costs of not taking discounts, given specific credit terms, and explain what stretching accounts payable is and how it reduces the cost of trade credit.
◆ Discuss some of the key features of bank loans and calculate simple and “add-on” interest.
◆ Explain why large, financially strong corporations issue commercial paper.
◆ Explain what accruals (accrued liabilities) are, and what is meant by the term “spontaneous funds.”
◆ Define what a “secured” loan is, and what type of collateral can be used to secure a loan.
Lecture Suggestions
We have never found working capital an interesting topic to students, hence it is, to us, a somewhat more difficult subject to teach than most. Perhaps that’s because it comes near the end of the course, when everyone is tired. More likely, though, the problem is that working capital management is really more a matter of operating efficiently than thinking conceptually correctly—i.e., it