Ch.

15:
Introduction to

Management
 2000, Prentice Hall, Inc.
 Working-Capital Management
 Current Assets
 cash, marketable securities, inventory,
accounts receivable
 Long-Term Assets
 equipment, buildings, land

 Which earn higher rates of return?

 Which help avoid risk of illiquidity?
 Working-Capital Management
 Current Assets
 cash, marketable securities, inventory,
accounts receivable
 Long-Term Assets
 equipment, buildings, land

 Risk-Return Trade-off:
Current assets earn low returns, but
help reduce the risk of illiquidity.
 Working-Capital Management
 Current Liabilities
 short-term notes, accrued expenses,
accounts payable
 Long-Term Debt and Equity
 bonds, preferred stock, common stock

 Which are more expensive for the firm?

 Which help avoid risk of illiquidity?
 Working-Capital Management
 Current Liabilities
 short-term notes, accrued expenses,
accounts payable
 Long-Term Debt and Equity
 bonds, preferred stock, common stock

 Risk-Return Trade-off:
Current liabilities are less expensive, but
increase the risk of illiquidity.
 Balance Sheet
Current Assets Current Liabilities

Fixed Assets Long-Term Debt

Preferred Stock
Common Stock

To illustrate, let’s finance all current assets

with current liabilities,
 Balance Sheet
Current Assets Current Liabilities

Fixed Assets Long-Term Debt

Preferred Stock
Common Stock

To illustrate, let’s finance all current assets

with current liabilities,
 Balance Sheet
Current Assets Current Liabilities

Fixed Assets Long-Term Debt

Preferred Stock
Common Stock

To illustrate, let’s finance all current assets

with current liabilities, and finance all
fixed assets with long-term financing.
 Balance Sheet
Current Assets Current Liabilities

Fixed Assets Long-Term Debt

Preferred Stock
Common Stock

To illustrate, let’s finance all current assets

with current liabilities, and finance all
fixed assets with long-term financing.
 Balance Sheet
Current Assets Current Liabilities

Fixed Assets Long-Term Debt

Preferred Stock
Common Stock
 Balance Sheet
Current Assets Current Liabilities

Fixed Assets Long-Term Debt

Preferred Stock
Common Stock

Suppose we use long-term financing to

finance some of our current assets.
 Balance Sheet
Current Assets Current Liabilities

Fixed Assets Long-Term Debt

Preferred Stock
Common Stock

Suppose we use long-term financing to

finance some of our current assets.
 Balance Sheet
Current Assets Current Liabilities

Fixed Assets Long-Term Debt

Preferred Stock
Common Stock

Suppose we use long-term financing to

finance some of our current assets.
This strategy would be less risky, but more
expensive!
 Balance Sheet
Current Assets Current Liabilities

Fixed Assets Long-Term Debt

Preferred Stock
Common Stock
 Balance Sheet
Current Assets Current Liabilities

Fixed Assets Long-Term Debt

Preferred Stock
Common Stock

Suppose we use current liabilities to

finance some of our fixed assets.
 Balance Sheet
Current Assets Current Liabilities

Fixed Assets Long-Term Debt

Preferred Stock
Common Stock

Suppose we use current liabilities to

finance some of our fixed assets.
 Balance Sheet
Current Assets Current Liabilities

Fixed Assets Long-Term Debt

Preferred Stock
Common Stock

Suppose we use current liabilities to

finance some of our fixed assets.
This strategy would be less expensive, but
more risky!
 The Hedging Principle
 Permanent Assets (those held > 1 year)
 should be financed with permanent and
spontaneous sources of financing.
 Temporary Assets (those held < 1 year)
 should be financed with temporary
sources of financing.
 Balance Sheet
Temporary
Current Assets
 Balance Sheet
Temporary Temporary
Current Assets Short-term financing
 Balance Sheet
Temporary Temporary
Current Assets Short-term financing

Permanent
Fixed Assets
 Balance Sheet
Temporary Temporary
Current Assets Short-term financing

Permanent Permanent
Fixed Assets Financing
and
Spontaneous
Financing
The Hedging Principle
 Permanent Financing
 intermediate-term loans, long-term debt,
preferred stock, common stock
 Spontaneous Financing
 accounts payable that arise spontaneously
in day-to-day operations (trade credit,
wages payable, accrued interest and taxes)
 Short-term financing
 unsecured bank loans, commercial paper,
loans secured by A/R or inventory
 Cost of Short-Term Credit

Interest = principal x rate x time

ex: borrow $10,000 at 8.5% for 9 months

Interest = $10,000 x .085 x 3/4 year

= $637.50
Cost of Short-Term Credit

We can use this simple relationship:

Interest = principal x rate x time
to solve for rate, and get the
Cost of Short-Term Credit

We can use this simple relationship:

Interest = principal x rate x time
to solve for rate, and get the
Annual Percentage Rate (APR)
Cost of Short-Term Credit

We can use this simple relationship:

Interest = principal x rate x time
to solve for rate, and get the
Annual Percentage Rate (APR)

interest 1
APR = x
principal time
Cost of Short-Term Credit
Cost of Short-Term Credit

interest 1
APR = x
principal time
 Cost of Short-Term Credit

interest 1
APR = x
principal time

example: If you pay $637.50 in

interest on $10,000 principal for 9
months:
 Cost of Short-Term Credit

interest 1
APR = x
principal time

example: If you pay $637.50 in

interest on $10,000 principal for 9
months:

APR = 637.50/10,000 x 1/.75 = .085

= 8.5% APR
 Cost of Short-Term Credit

Annual Percentage Yield (APY) is

similar to APR, except that it
accounts for compound interest:
 Cost of Short-Term Credit

Annual Percentage Yield (APY) is

similar to APR, except that it
accounts for compound interest:

(1+ ) i m

APY = m - 1
 Cost of Short-Term Credit

Annual Percentage Yield (APY) is

similar to APR, except that it
accounts for compound interest:

(1+ ) i m

APY = m - 1
i = the nominal rate of interest
m = the # of compounding periods per year
 Cost of Short-Term Credit

What is the (APY) of a 9% loan with

monthly payments?

APY = ( 1 + ( .09 / 12 ) 12 -1 ) = .0938

= 9.38%
Sources of Short-term Credit
 Unsecured
Sources of Short-term Credit
 Unsecured
 accrued wages and taxes
Sources of Short-term Credit
 Unsecured
 accrued wages and taxes
 trade credit
Sources of Short-term Credit
 Unsecured
 accrued wages and taxes
 trade credit
 bank credit
Sources of Short-term Credit
 Unsecured
 accrued wages and taxes
 trade credit
 bank credit
 commercial paper
Sources of Short-term Credit
 Unsecured
 accrued wages and taxes
 trade credit
 bank credit
 commercial paper

 Secured
Sources of Short-term Credit
 Unsecured
 accrued wages and taxes
 trade credit
 bank credit
 commercial paper

 Secured
 accounts receivable loans
Sources of Short-term Credit
 Unsecured
 accrued wages and taxes
 trade credit
 bank credit
 commercial paper

 Secured
 accounts receivable loans
 inventory loans