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Asset & Capital Management: Working capital, financing policy, debt vs equity financing

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Please answer each question thoroughly and show work for each problem.

The answer is based on the following reference material:

Course material: Financial Management: Concepts and Applications for Health Care Organizations 4th Ed. Bruce R. Neumann, PH.D, Jan P.Clement,PH.D., Jean C.Cooper,PH.D.

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1. What are two problems that may be caused by too much working capital, and what are two problems that may be caused by too little working capital?

Gross working capital is the amount invested in current assets. Net Working capital is the difference between current assets and current liabilities. It is necessary to maintain the optimum working capital i.e., neither excess nor deficit working capital.

Problems caused by excess working capital:

1. The first problem of excessive working capital that is the company is losing the interest on the excess money as the company would have earned if it had invested the excess working capital in other investments. For example, the right amount of working capital is $100000 and the present working capital being $140000. Presently, the company is earning interest of 6% in its short term investments. If the company has invested $40000 being excess working capital ($140000-$100000), then it would have earned the interest of $2400. By simply holding excess cash, the company has lost $2400 interest per annum.

2. Excess working capital may result in overall inefficiency in the organization.

Problems caused by too little working capital:

1. If the company has little working capital i.e., lesser than the right amount of working capital it is difficult for the company to repay its debts when due. This will result in loss of reputation to the company and also the company will be charged by the creditors for the non -payment on the due dates. This is the additional financial costs on the company.

2. Rate of return on investments will also fall because of the insufficient working capital.

3. What are the relative advantages and disadvantages of a conservative asset financing policy and an aggressive asset financing policy?

Aggressive asset financing policy utilizes higher amount of current liabilities and less amount of long term debt. In aggressive financing policy the company uses short term less expensive funds. Advantages of aggressive financing policies are 1. Cost of funds is less as short term funds carry less interest rate than the long term funds. 2. It will increase the overall profitability of the company. The disadvantage of aggressive financing policy is that the company has to repay the short term funds at a short span of time. There may be the possibility of company running short of cash to repay the short term debt.

Conservative financing policy uses more long term debt and capital and less current liabilities. The ...

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Working Capital Management Problem

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Working Capital Management

Explain how you reached the answer or show your work if a mathematical calculation is needed, or both.

1. Swim Suits Unlimited is in a highly seasonal business, and the following summary balance sheet data show its assets and liabilities at peak and off-peak seasons (in thousands of dollars):

Peak Off-Peak
Cash $ 50 $ 30
Marketable securities 0 20
Accounts receivable 40 20
Inventories 100 50
Net fixed assets 500 500
Total assets $690 $620

Payables and accruals $ 30 $ 10
Short-term bank debt 50 0
Long-term debt 300 300
Common equity 310 310
Total claims $690 $620

From this data we may conclude that
a. Swim Suits' current asset financing policy calls for exactly matching asset and liability maturities.
b. Swim Suits' current asset financing policy is relatively aggressive; that is, the company finances some of its permanent assets with short-term discretionary debt.
c. Swim Suits follows a relatively conservative approach to current asset financing; that is, some of its short-term needs are met by permanent capital.
d. Without income statement data, we cannot determine the aggressiveness or conservatism of the company's current asset financing policy.
e. Without cash flow data, we cannot determine the aggressiveness or conservatism of the company's current asset financing policy.

2. Which of the following statements is CORRECT?

a. A firm that makes 90% of its sales on credit and 10% for cash is growing at a constant rate of 10% annually. Such a firm will be able to keep its accounts receivable at the current level, since the 10% cash sales can be used to finance the 10% growth rate.
b. In managing a firm's accounts receivable, it is possible to increase credit sales per day yet still keep accounts receivable fairly steady, provided the firm can shorten the length of its collection period (its DSO) sufficiently.
c. Because of the costs of granting credit, it is not possible for credit sales to be more profitable than cash sales.
d. Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must also have a high payables-to-sales ratio.
e. Other things held constant, if a firm can shorten its DSO, this will lead to a higher current ratio.

3. Halka Company is a no-growth firm. Its sales fluctuate seasonally, causing total assets to vary from $320,000 to $410,000, but fixed assets remain constant at $260,000. If the firm follows a maturity matching (or moderate) working capital financing policy, what is the most likely total of long-term debt plus equity capital?

a. $260,642
b. $274,360
c. $288,800
d. $304,000
e. $320,000

4. Your consulting firm was recently hired to improve the performance of Shin-Soenen Inc, which is highly profitable but has been experiencing cash shortages due to its high growth rate. As one part of your analysis, you want to determine the firmâ??s cash conversion cycle. Using the following information and a 365-day year, what is the firmâ??s present cash conversion cycle?
Average inventory = $75,000
Annual sales = $600,000
Annual cost of goods sold = $360,000
Average accounts receivable = $160,000
Average accounts payable = $25,000

a. 120.6 days
b. 126.9 days
c. 133.6 days
d. 140.6 days
e. 148.0 days

5. Affleck Inc.'s business is booming, and it needs to raise more capital. The company purchases supplies on terms of 1/10 net 20, and it currently takes the discount. One way of getting the needed funds would be to forgo the discount, and the firm's owner believes she could delay payment to 40 days without adverse effects. What would be the effective annual percentage cost of funds raised by this action? (Assume a 365-day year.)

a. 10.59%
b. 11.15%
c. 11.74%
d. 12.36%
e. 13.01%

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