CORPORATE FINANCIAL PLANNING

Master in Finance

Problem Set: Short- Term Financing

1. Working Capital Management

2. Short-Term Financial Planning

Ana Venâncio
@ 2016
1.
The following is the balance sheet for Ford Motor Company as of December 31,
2002 (in millions)

Assets Liabilities and Equity

Cash $19,927 Accounts Payable $11,635
Accounts Receivable 61,469 Debt due within 1 year 36,240
Inventory 10,128 Other Current Liabilities 2,721
Current Assets 91,524 Current liabilities 50,596
Fixed Assets 45,586 Short-Term Debt 36,200
Long-Term Debt 37,490
Equity 12,824

Total Assets $137,110 Total Liabilities and Equity $137,110

The firm had revenues of $154,951 million in 2002 and cost of goods sold of
$103,817 million.

1. Estimate the net working capital.

2. Estimate the noncash working capital.
3. Why is Ford’s working capital so high? If you were told Ford Capital (Ford’s
financing arm) was consolidated into the balance sheet, would that help your
explanation?
4. Estimate the noncash working capital as a percent of revenues. If you were asked
to estimate the noncash working capital needs for a new automobile factory that
Ford was constructing, would you use this ratio?

2.
At the end of 2012, Firm B has an average accounts payable balance of $250,000
and VAT is 23%. The cost of goods sold is $4,154,472 and the firm receives on
terms of 2/15, Net 40 from its suppliers. Firm B chooses to forgo the discount. Is
the firm managing its account payable well?

3.
A plumbing service is considering offer 30-day credit to customers. The firm wants
to charge them an annualized rate of 24%. Considering that the cash discount is for
immediate payment, how much would the discount have to be?

2
4.
What is the effective annual cost of credit terms of 1/15, Net 40 if the firm
stretches the account payable to 60 days?

5.
Estimate the optimal cash balance by the Baumol Model for an automobile supplies
firm that has the following characteristics:
• The annual cash usage rate for the firm is $10 million
• The cost per sale of securities is $50
• The annual interest rate is 10%

6.
Estimate the optimal cash balance for a computer software firm with uncertain cash
flows. The firm has the following characteristics:
• The standard deviation in daily cash balances is $10,000; the variance is
$100 million.
• The minimum cash balance this firm has to maintain is $100,000.
• The interest rate, on a daily basis, is 0.01%
• The transaction cost for each sale or purchase of securities is $50

7.
A retail firm has sales of $150 million and inventory of $30 million. The firm has an
after-tax operating margin of 10%, expects revenues and cash-flows to grow 5% in
the long term and has a cost of capital of 10%. Although this firm has traditionally
maintained inventory at 20% of sales, it is considering lowering inventories to 15%
of sales. Although this will provide a benefit in terms of cash-flow, it is anticipated
that revenues will immediately drop by 2% and that expected growth will be 4.75%
instead of 5%.
Estimate the impact of the change in inventory on firm value.

8.
The Company Abercrombie & Fitch has $1 billion of cash surplus and it is
considering three alternatives:
a) It can buy a 180-day treasury bill that are currently quoted at a yield on a
bank discount basis of 5.6%

3
 b) It can buy commercial paper by Google Inc., which is rated A1+ by S&P, the
highest possible rating. The interest rate, over six months, not annualized, is
2.98%.
c) It can enter into a repurchase agreement to buy $1.029 billion of treasury
bills for $1 billion, with a dealer in securities. The dealer promises to deliver
$1.029 billion to you in six months.
1- Estimate the annualized return on each of these investments 2-
Why do returns differ across investments?

3- How would you decide which investment or investments you would invest your
cash in?

9.
Apple Inc has a $100,000 cash surplus for 120 days. Discuss the best maximizing
alternative:
a) It can deposit on PNC bank at benchmark interest rate deducted of a spread
of 0.2%. The 4 month LIBOR rate is 1.3%
b) It can buy commercial paper by Google Inc, which is rated A1+ by S&P and
with a face value of $101,800 and a maturity of 120 days
c) It can buy 120-day treasury bill with a face value of $101,500.
d) It can take advantage of the discount to pay their suppliers. The goods were
bought on terms 0.75/30, Net 120. In addition, it can deposit on PNC bank
at benchmark interest rate deducted of a spread of 0.1%. The 1 month
LIBOR rate is 0.4%

10.
Whole Foods, Co sells natural and organic foods. The following table contains firm’s
income statement forecast:

Months

($000) 0 1 2 3 4 5 6
Net Sales 8 10 10 20 20 30 10
Cost of Sales 6.4 8 8 16 16 24 8

Gross Profit 1.6 2 2 4 4 6 2

General Expenses -0.5 -0.5 -0.5 -0.5 -0.5 -0.5
Depreciation -1 -1 -2 -2 -2 -2 -2
Other Income 1 2 2 2 2 2 2

Operating Income 1.6 2.5 1.5 3.5 3.5 5.5 1.5

4
 Taxes 0.4 0.625 0.375 0.875 0.875 1.375 0.375

Net Income 1.2 1.875 1.125 2.625 2.625 4.125 1.125

The current (month 0) working capital levels are presented in the following table:

Month 0

Levels of Working Capital

Accounts Receivable 2,000
Initial Inventory 7,000
Accounts Payable 10,640

Assume that the firm purchases goods from its supplier on Net 60 and it bills its
accounts receivable for 30 days. On Month 2, the firm plans to buy a new storage
facility for $10,000. In month 0, the firm purchases $10,640 in inventory and has
initial stocks of $7,000. The purchases occurs uniformly throughout the months.

1- During which months are the firm’s working capital needs the greatest?
2- When does it have cash surplus?
3- What are the permanent working capital needs of your company? What are the
temporary needs?

11.
The Whirlpool Corp. needs a $100,000 loan for the next 30 days. It is trying to
decide which of five alternatives to use:
a) Forgo the discount on its trade credit agreement that offers terms of 2/10,
Net 30
b) Borrow the money from Bank A for 30 days at an APR of 12% (compounded
monthly). The bank will require a (no-interest) compensating balance of 5%
of the face value of the loan and will charge a $1,000 loan origination fee
c) Borrow the money from Bank B for 30 days at an APR of 15% (compounded
monthly). The loan has a 0.5% loan origination fee.
d) Issue commercial paper with a face value of $104,800 and a maturity of one
month. The net proceeds of selling the paper are $100,000.

5
 e) Borrow $100,000 for one month at the stated annual rate of 13%
(compounded monthly), using the inventory stored in a field warehouse as
collateral. The warehouse charges a $500 fee, payable in the end of the
month.

Which alternative is the cheapest source of financing for Whirlpool Corp.?

12.
Which of the following one-year $1,000 bank loans offers the lowest effective
annual rate?
a) A loan with an APR of 6.5%, compounded monthly
b) A loan with an APR of 6%, compounded annually, that also has a
compensating balance requirement of 10%, on which no interest is paid
c) A loan with an APR of 6%, compounded annually, that has a 1% loan
origination fee
The effective annual rates of each of the alternatives are calculated as follows.

13.
The Colgate-Palmolive needs a $100,000 loan for the next 180 days. The firm is
trying to decide between the following alternatives:
a) Offer its clients a trade credit term of 0.75/15, Net 60
b) Sell their account receivables to a factor firm. The benchmark interest rate is
2 month Euribor rate +1 %. The 2 month Euribor rate is 4%. Assume that the
Colgate trade credit term is 2 months. The stamp duty is 4% and the flat
commission of the factor firm is 0.5%.
c) Borrow the money from Bank A for 30 days at the monthly APR benchmark
interest rate plus a spread of 0.75%. The 1 month Euribor rate is 3.5%. The
stamp duty is 4%.

Which alternative is the cheapest source of financing for Colgate-Palmolive?