CHAPTER 19

SHORT-TERM FINANCE AND

PLANNING
Answers to Concepts Review and Critical Thinking Questions

1. These are firms with relatively long inventory periods and/or relatively long receivables periods. Thus,
such firms tend to keep inventory on hand, and they allow customers to purchase on credit and take a
relatively long time to pay.

2. These are firms that have a relatively long time between the time purchased inventory is paid for and
the time that inventory is sold and payment received. Thus, these are firms that have relatively short
payables periods and/or relatively long receivable cycles.

3. a. Use: The cash balance declined by $200 to pay the dividend.

b. Source: The cash balance increased by $500, assuming the goods bought on payables credit
were sold for cash.
c. Use: The cash balance declined by $900 to pay for the fixed assets.
d. Use: The cash balance declined by $625 to pay for the higher level of inventory.
e. Use: The cash balance declined by $1,200 to pay for the redemption of debt.

4. Carrying costs will decrease because they are not holding goods in inventory. Shortage costs will
probably increase depending on how close the suppliers are and how well they can estimate need. The
operating cycle will decrease because the inventory period is decreased.

5. Since the cash cycle equals the operating cycle minus the accounts payable period, it is not possible
for the cash cycle to be longer than the operating cycle if the accounts payable is positive. Moreover,
it is unlikely that the accounts payable period would ever be negative since that implies the firm pays
its bills before they are incurred.

6. It lengthened its payables period, thereby shortening its cash cycle.

7. Their receivables period increased, thereby increasing their operating and cash cycles.

8. It is sometimes argued that large firms “take advantage of” smaller firms by threatening to take their
business elsewhere. However, considering a move to another supplier to get better terms is the nature
of competitive free enterprise.

9. They would like to! The payables period is a subject of much negotiation, and it is one aspect of the
price a firm pays its suppliers. A firm will generally negotiate the best possible combination of
payables period and price. Typically, suppliers provide strong financial incentives for rapid payment.
This issue is discussed in detail in a later chapter on credit policy.
 CHAPTER 19 B-157

10. Ameritech will need less financing because it is essentially borrowing more from its suppliers. Among
other things, Ameritech will likely need less short-term borrowing from other sources, so it will save
on interest expense.
B-158 SOLUTIONS

Solutions to Questions and Problems

Basic

1. a. N b. N c. N d. D e. D
f. D g. N h. D i. I j. D
k. D l. N m. D n. D o. I

2. Cash = $8,500 + 1,800 – 2,200 – 2,250 = $5,850

Current assets = $2,250 + 1,000 + $5,850 = $9,100

3. a. I b. I c. D
d. N e. D f. N

4. first letter is cash cycle, a. I; I b. I; N c. D; D

second is operating cycle. d. D; D e. D; N f. I; I

5. a. 45-day collection period implies all receivables outstanding from the previous quarter are
collected in the current quarter, and (90-45)/90 = 1/2 of current sales are collected.

Q1 Q2 Q3 Q4

Beginning receivables $200 $300 $360 $400

Sales 600 720 800 640
Cash collections (500) (660) (760) (720)
Ending receivables $300 $360 $400 $320

b. 60-day collection period implies all receivables outstanding from previous quarter are collected
in the current quarter, and (90-60)/90 = 1/3 of current sales are collected.

Q1 Q2 Q3 Q4

Beginning receivables $200 $400 $480 $533

Sales 600 720 800 640
Cash collections (400) (640) (747) (746)
Ending receivables $400 $480 $533 $427

c. 30-day collection period implies all receivables outstanding from previous quarter are collected
in the current quarter, and (90-30)/90 = 2/3 of current sales are collected.

Q1 Q2 Q3 Q4

Beginning receivables $200 $200 $240 $267

Sales 600 720 800 640
Cash collections (600) (680) (773) (694)
Ending receivables $200 $240 $267 $213
 CHAPTER 19 B-159

6. Inventory turnover = $51,912/{[$7,281 + 9,319]/2} = 6.2548 times

Inventory period = 365 days/6.2548 = 58.355 days
Receivables turnover = $65,180/{[$4,814 + 5,108]/2} = 13.1385 times
Receivables period = 365 days/13.1385 = 27.781 days
Operating cycle = 58.355 + 26.781 = 86.136 days
Payables turnover = $51,912/{[$6,623 + 7,415]/2} = 7.3959 times
Payables period = 365 days/7.3959 = 49.3515 days
Cash cycle = 86.136 – 49.3515 = 36.784 days
The firm is receiving cash on average 36.784 days after it pays its bills.

7. number of periods = 365/42 = 8.6905; EAR = (1 + 2/98)8.6905 – 1 = 19.19%

8. a. The payables period is zero since the company pays immediately.

Payment in each period = 0.30 times next period sales.

Q1 Q2 Q3 Q4

Payment of accounts $157.50 $195.00 $150.00 $155.25

b. Since the payables period is 90 days, payment in each period = 0.3 times current period sales.

Q1 Q2 Q3 Q4

Payment of accounts $135.00 $157.50 $195.00 $150.00

c. Since the payables period is 60 days, payment in each period = 2/3 of last quarter’s orders, and
1/3 of this quarter’s orders, or 2/3(.30) times current sales + 1/3(.30) next period sales.

Q1 Q2 Q3 Q4

Payment of accounts $142.50 $170.00 $180.00 $151.75

9. Since the payables period is 60 days, payables in each period = 2/3 of last quarter’s orders, and 1/3 of
this quarter’s orders, or 2/3(.75) times current sales + 1/3(.75) next period sales.

Q1 Q2 Q3 Q4

Payment of accounts $575.00 $662.50 $575.00 $505.00

Wages, taxes, other expenses 140.00 180.00 170.00 120.00
Long-term financing expenses 60.00 60.00 60.00 60.00
(interest and dividends)
Total $775.00 $902.50 $805.00 $685.00

10. a. November sales = ($60,000 – 26,000)/0.15 = $226,666.67

b. December sales = $26,000/0.35 = $74,285.71
c. January collections = .15($226,667.67) + .20($74,285.71) + .65($140,000) = $139,857.29
February collections = .15($74,285.71) + .20($140,000) + .65($162,000) = $144,442.86
March collections = .15($140,000) + .20($162,000) + .65($180,000) = $170,400.00
B-160 SOLUTIONS
 CHAPTER 19 B-161

11. Sales collections = .35 times current month sales + .60 times previous month sales.

April May June

Beginning cash balance $300,000 $285,500 $365,900
Cash receipts
Cash collections from
credit sales 241,500 328,200 374,400
Total cash available $541,500 $613,700 $740,300
Cash disbursements
Purchases 156,000 132,000 150,000
Wages, taxes, and expenses 20,400 22,200 25,200
Interest 9,600 9,600 9,600
Equipment purchases 70,000 84,000 0
Total cash disbursements 256,000 247,800 184,800
Ending cash balance $285,500 $365,900 $555,500

Intermediate

12. a. Borrow $50M for one month, pay $260,000 in interest, but you only get the use of $48M.
EAR = [1 + ($260,000/$48M)]12 – 1 = 6.697%
b. to end up with $10M, you must borrow $10M/.96 = $10,416,666.67
total interest paid = $10,416,666.67 (1.0052)6 – 10,416,666.67 = $329,254.41

13. a. EAR = 1.01504 – 1 = 6.14%

b. opportunity cost = .06($20M)(1.0150)4 – .06($20M) = $73,636.26
interest cost = $40M(1.019)4 – 40M = $3,127,742.65
EAR = ($3,127,742.65 + 73,636.26)/$40M = 8.003%
c. EAR = 1.0194 – 1 = 7.82%

14. a. 45-day collection period means sales collections = 1/2 current sales + 1/2 old sales
36-day payables period means payables = 3/5 current orders + 2/5 old orders
cash inflows:
Q1 = $76 + 1/2($210) – 2/5(.45)($210) – 3/5(.45)($180) – .30($210) – $15 = $16.60
Q2 = 1/2($210) + 1/2($180) – 2/5(.45)($180) – 3/5(.45)($240) – .30($180) – $15 – 90 = –$61.20
Q3 = 1/2($180) + 1/2($240) – 2/5(.45)($240) – 3/5(.45)($270) – .30($240) – $15 = $6.90
Q4 = 1/2($240) + 1/2($270) – 2/5(.45)($270) – 3/5(.45)($225) – .30($270) – $15 = $49.65
WILDCAT, INC.
Short-Term Financial Plan
(in millions)
Q1 Q2 Q3 Q4
Beginning cash balance $68.00 $84.60 $23.40 $30.30
Net cash inflow 16.60 (61.20) 6.90 49.65
Ending cash balance $84.60 $23.40 $30.30 $79.95
Minimum cash balance (30.00) (30.00) (30.00) (30.00)
Cumulative surplus (deficit) $54.60 ($ 6.60) $ 0.30 $49.95
B-162 SOLUTIONS

WILDCAT, INC.
Short-Term Financial Plan
(in millions)
b. Q1 Q2 Q3 Q4
Beginning cash balance $30.00 $30.00 $30.00 $30.00
Net cash inflow 16.60 (61.20) 6.90 49.65
New short-term investments (17.36) 0 (2.03) (49.69)
Income on short-term investments 0.76 1.11 0 0.04
Short-term investments sold 0 55.36 0 0
New short-term borrowing 0 4.73 0 0
Interest on short-term borrowing 0 0 (0.14) 0
Short-term borrowing repaid 0 0 (4.73) 0
Ending cash balance $30.00 $30.00 $30.00 $30.00
Minimum cash balance (30.00) (30.00) (30.00) (30.00)
Cumulative surplus (deficit) $ 0 $ 0 $ 0 $ 0

Beginning short-term investments $38.00 $55.36 $0 $2.03

Ending short-term investments $55.36 0 $2.03 $51.72
Beginning short-term debt 0 0 $4.73 0
Ending short-term debt 0 $4.73 0 0

Q1: excess funds at start of quarter of $38 invested for 1 quarter earns .02($38) = $0.76 income
Q2: excess funds of $55.36 invested for 1 quarter earns .02($55.36) = $1.11 in income
Q3: shortage funds of $4.73 borrowed for 1 quarter costs .03($4.73) = $0.14 in interest
Q4: excess funds of $2.03 invested for 1 quarter earns .02($2.03) = $0.04 in income

15. a. WILDCAT, INC.

Short-Term Financial Plan
(in millions)
Q1 Q2 Q3 Q4
Beginning cash balance $45.00 $45.00 $45.00 $45.00
Net cash inflow 16.60 (61.20) 6.90 49.65
New short-term investments (17.06) 0 0 (35.18)
Income on short-term investments 0.46 0.80 0 0
Short-term investments sold 0 40.06 0 0
New short-term borrowing 0 20.34 0 0
Interest on short-term borrowing 0 0 (0.61) (0.42)
Short-term borrowing repaid 0 0 (6.29) (14.05)
Ending cash balance $45.00 $45.00 $45.00 $45.00
Minimum cash balance (45.00) (45.00) (45.00) (45.00)
Cumulative surplus (deficit) $0 $0 $0 $0

Beginning short-term investments $23.00 $40.06 0 0

Ending short-term investments $40.06 0 0 $35.18
Beginning short-term debt 0 0 $20.34 $14.05
Ending short-term debt 0 $20.34 $14.05 0
CHAPTER 19 B-163
B-164 SOLUTIONS

b. WILDCAT, INC.
Short-Term Financial Plan
(in millions)
Q1 Q2 Q3 Q4
Beginning cash balance $15.00 $15.00 $15.00 $15.00
Net cash inflow 16.60 (61.20) 6.90 49.65
New short-term investments (17.66) 0 (7.12) (50.01)
Income on short-term investments 1.06 1.41 0.22 0.36
Short-term investments sold 0 59.79 0 0
New short-term borrowing 0 0 0 0
Interest on short-term borrowing 0 0 0 0
Short-term borrowing repaid 0 0 0 0
Ending cash balance $15.00 $15.00 $15.00 $15.00
Minimum cash balance (15.00) (15.00) (15.00) (15.00)
Cumulative surplus (deficit)

Beginning short-term investments $53.00 $70.66 $10.87 $17.99

Ending short-term investments $70.66 $10.87 $17.99 $68.00
Beginning short-term debt 0 0 0 0
Ending short-term debt 0 0 0 0

Since cash has an opportunity cost, the firm can boost its profit if it keeps its minimum cash balance
low and invests the cash instead. However, the tradeoff is that in the event of unforeseen
circumstances, the firm may not be able to meet its short-run obligations if not enough cash is
available.

Challenge

16. a. For every $1 borrowed, you pay $0.018 in interest and get to use $0.95.
EAR = [(1.018)4 – 1]/.95 = 7.786%
b. EAR = $550[(1.018)4 – 1]/[.95($550) – .00105($750)] = 7.798%

17. You’re paying $210,000 in interest, but you only get the use of $2,550,000, the combination of the
discount loan ($210,000) and the compensating balance ($240,000).
EAR = $210,000/$2,550,000 = 8.24%