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Working Capital Management And The Financing Decision

6464 words - 26 pages

Chapter 6

Discussion Questions

|6-1. |Explain how rapidly expanding sales can drain the cash resources of a firm. |
| | |
| |Rapidly expanding sales will require a buildup in assets to support the growth. In particular, more and more of the |
| |increase in current assets will be permanent in nature. A non-liquidating aggregate stock of current assets will be |
| |necessary to allow for floor displays, multiple items for selection, ...view middle of the document...

Matching sales and production has the advantage of |
| |maintaining smaller amounts of current assets than level production, and therefore less financing costs are incurred.|
| |However, if sales are seasonal or cyclical, workers will be laid off in a declining sales climate and machinery |
| |(fixed assets) will be idle. Here lies the tradeoff between level and seasonal production: Full utilization of fixed |
| |assets with skilled workers and more financing of current assets versus unused capacity, training and retraining |
| |workers, with lower financing for current assets. |
| | |
|6-4. |How is a cash budget used to help manage current assets? |
| | |
| |A cash budget helps minimize current assets by providing a forecast of inflows and outflows of cash. It also |
| |encourages the development of a schedule as to when inventory is produced and maintained for sales (production |
| |schedule), and accounts receivables are collected. The cash budget allows us to forecast the level of each current |
| |asset and the timing of the buildup and reduction of each. |
| | |
|6-5. |“The most appropriate financing pattern would be one in which asset buildup and length of financing terms is |
| |perfectly matched.” Discuss the difficulty involved in achieving this financing pattern. |
| | |
| |Only a financial manager with unusual insight and timing could design a plan in which asset buildup and the length of|
| |financing terms are perfectly matched. One would need to know exactly what current assets are temporary and which |
| |ones are permanent. Furthermore, one is never quite sure how much short-term or long-term financing is available at |
| |all times. Even if this were known, it would be difficult to change the financing mix on a continual basis. |
| | ...

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