502 Part 6 Working Capital Management, Forecasting, and Multinational Financial Management
h. Credit policy; credit period; discounts; credit standards; collection policy; credit
terms; credit score
i. Trade credit; free versus costly trade credit
j. Promissory note; line of credit; revolving credit agreement
k. Prime rate; simple interest; add-on interest
l. Commercial paper; accruals; spontaneous funds
m. Secured loan
WORKING CAPITAL POLICY Calgary Company is thinking of modifying its working capi-
tal assets policy. Fixed assets are $600,000, sales are projected at $3 million, the EBIT/sales
ratio is projected at 15%, the interest rate is 10% on all debt, the federal-plus-state tax rate
is 40%, and Calgary plans to maintain a 50% debt-to-assets ratio. Three alternative current
asset policies are under consideration: 40%, 50%, and 60% of projected sales. What is the
expected return on equity under each alternative?
CURRENT ASSET FINANCING Vanderheiden Press Inc. and Herrenhouse Publishing
Company had the following balance sheets as of December 31, 2008 (thousands of dollars):Vanderheiden Press Herrenhouse Publishing
Current assets $100,000 $ 80,000
Fixed assets (net) 100,000 120,000
Total assets $200,000 $200,000Current liabilities $ 20,000 $ 80,000
Long-term debt 80,000 20,000
Common stock 50,000 50,000
Retained earnings 50,000 50,000
Total liabilities and equity $200,000 $200,000Earnings before interest and taxes for both firms are $30 million, and the effective federal-
plus-state tax rate is 40%.
a. What is the return on equity for each firm if the interest rate on current liabilities is
10% and the rate on long-term debt is 13%?
b. Assume that the short-term rate rises to 20%. While the rate on new long-term debt
rises to 16%, the rate on existing long-term debt remains unchanged. What would be
the returns on equity for Vanderheiden Press and Herrenhouse Publishing under
these conditions?
c. Which company is in a riskier position? Why?What are some pros and cons of holding high levels of current assets in relation to sales?
Use the DuPont equation to help explain your answer.
Define cash conversion cycle (CCC). Explain why, holding other things constant, a firm’s
profitability would increase if it lowered its CCC.
What are the two definitions of cash, and why do corporate treasurers often use the
second definition?
What is a cash budget, and how can this statement be used to help reduce the amount of
cash that a firm needs to carry? What are the advantages and disadvantages of daily over
monthly cash budgets, and how might a cash budget be used when a firm is negotiating a
loan from its bank?