CURRENT ASSETS MANAGEMENT: VALUE BASED WORKING CAPITAL DECISIONS (2/5) 20th October 2008 @ 4pm

CURRENT ASSETS MANAGEMENT: VALUE BASED WORKING CAPITAL DECISIONS E-mail: GRZEGORZ.MICHALSKI@UE.WROC.PL www: HTTP://MICHALSKIG.UE.WROC.PL/ ph.: 0048717183313 Next lecture: 27th October 2008.

Cash cycle & Operating Cycle

How changes in curent assets influence value? CS: Inventory period = 35 days, Accounts receivable period = 26 days, accounts payable period = 20 days, Cash Revenues = 1234, T=19%, calculate: Assets, if FA = 800 Capital Involved FCF0, FCF1-n, FCFn IRR Cost of Capital if D/(D+E) = 40%, kd = 13% & ke = 34%. NPV What will change if IP is shorter? Longer? What will change if ARP is shorter? Longer? What will change if APP is shorter? Longer?

Liquid assets level & Firm Value n n

Liquidity level & Profitability

Liquidity level & Value of Liquidity Where: vi = intrinsic (internal) value of liquidity, vm = market value of liquidity, pp1 = liquidity level (1) for vi > vm ppopt = optimal liquidity level for vi = vm

Liquidity level & Value of Liquidity Where: vi = intrinsic (internal) value of liquidity, vm = market value of liquidity, pp2 = liquidity level (2) for vi < vm ppopt = optimal liquidity level for vi = vm

Liquidity measurement current ratio: current assets to current liabilities Example: Calculate Current Ratio if: Inventory = 60, Accounts receivable = 80; Accounts payable = 50; Cash and near cash = 4

Liquidity measurement quick ratio is current assets without inventories to current liabilities Example: Calculate Quick Ratio if: Inventory = 60, Accounts receivable = 80; Accounts payable = 50; Cash and near cash = 4

Short-term Financial decisions – NWC policies Short-term Financial decisions – NWC policies. Flexible or Restrictive policy The size of the firm’s investment in current assets is determined by its NWC financial policies. Flexible policy actions include: keeping large cash and securities’ balances; keeping large amounts of inventory; granting liberal credit terms. Restrictive policy actions include: keeping low cash and securities’ balances; keeping small amounts of inventory; allowing few or no credit sales.

Costs of Investments in Working Capital Need to manage the trade-off between carrying costs and shortage costs. Carrying costs increase with the level of investment in current assets, and include the costs of maintaining economic value and opportunity costs. Shortage costs decrease with increases in the level of investment in current assets, and include trading costs and the costs related to being short of the current asset. For example, sales lost as a result of a shortage of finished goods inventory.

Alternative Asset Financing Policies Working Capital [WC] & WC financing Alternative Asset Financing Policies

Alternative Asset Financing Policies Working Capital [WC] & WC financing Alternative Asset Financing Policies

Alternative Asset Financing Policies Working Capital [WC] & WC financing Alternative Asset Financing Policies

Example NWC-1a.

Example NWC-2.

Example NWC-1b What will change if: Long-term debt share in aggressive strategy = 35% with long-term debt rate = 11% and short-term debt = 9% and with equity cost rate 28% Long-term debt share in compromise strategy = 75% with long-term debt rate = 10% and short-term debt = 8% and with equity cost rate 26% Long-term debt share in conservative strategy = 95% with long-term debt rate = 9,5% and short-term debt = 7,5% and with equity cost rate 24,5%