Please discuss the following topics:
1. Why is too much liquidity not a good thing?
2. Why is the ROE a more appropriate proxy of wealth maximization for smaller firms rather than for larger ones?
3. Why is it not enough for an analyst to look at just the short-term and long-term debt on a firm's balance sheet?
Please use Financial Decision Making for Managers by Parrino & Kidwell
Too much liquidity is not a good thing. First, liquidity represents cash that could have been placed in an investment. The investment can be in terms of working capital of the company, increasing its earnings/revenue, the investment can be in terms of capital goods that can be used to generate a new stream of income, or the investment can be external. External investment can be in property, bonds, or shares of another company. In each of the cases described above there is an increase in the income of the firm. So if the money is held liquid, there is an opportunity cost incurred for holding liquid money. The more the liquid money is held in cash the more is the opportunity cost. This is why holding too much liquidity is ...
The write up gives a learned discussion on too much liquidity