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Asset
Managemen
t
7
Prepared by:
Michel Paquet
SAIT Polytechnic
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Chapter 7 - Outline
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Learning Objectives
1. Extend Chapter 6 concepts of liquidity and risk
to current asset management recognizing that a
firms investment in current assets should
achieve an adequate return for its liquidity and
risk. (LO1)
2. Examine cash management as the control of
receipts and disbursements to minimize
nonearning cash balances while providing
liquidity and describe techniques to make cash
management more efficient. (LO2)
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Learning Objectives
3. Define the various marketable securities
available for investment by the firm and
calculate the yield on these instruments. (LO3)
4. Characterize accounts receivable as an
investment resulting from the firms credit
policies, outline the considerations in granting
credit, and evaluate a credit decision that
changes credit terms to stimulate sales. (LO4)
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Learning Objectives
5. Assess inventory as an investment and
apply techniques to reduce the costs of
this investment. (LO5)
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LO1
LO1
Cost-Benefit Analysis
Cost-benefit analysis provides a framework to
identify all the resultant changes arising from
a decision.
It must consider explicit and implicit costs and
benefits.
Opportunity costs are implicit costs and are
forgone benefits from next best alternatives.
-- e.g. opportunity costs of having capital tied up in
current assets are the lost benefits from investing
capital in other profitable investments.
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LO1
Cost-Benefit Analysis
Good value-adding decisions will ensue when
the benefits exceed the costs.
In general, the return (on investment, ROI) is
monies received
r
net capital tied up
LO2
Cash Management
Maintain optimum level of cash
Use the float
Speed up collections
Extend disbursements
Use cash budgets
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LO2
Cash Management
Financial managers want to keep cash
balances to a minimum
There are 2 reasons for holding cash
1. for everyday transactions (main reason)
2. for precautionary needs (emergencies)
LO2
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Low-risk, liquid
investments
Savings accounts
Money market funds
Term deposits
Treasury bills
US $ deposits
LO2
Table 7-1
+ $ 200,000
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LO2
Table 7-2
Initial amount
100,000
$ 100,000
Deposits + 1,000,000*
800,000*
Cheques
1,200,000
800,000
Balance
+ $ 100,000
$ 100,000
+ $200,000 float
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LO2
Lockbox System
when customers mail payment to a local post office box instead
of to the company headquarters
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LO2
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LO2
Figure 7-1
Local
Local
Office
Office
Local
Local
Office
Office
Local
Local
Office
Office
Local
Local
Office
Office
Local
bank
branch
Local
bank
branch
Local
bank
branch
Local
bank
branch
Local
bank
branch
Centralbank
bankaccount
account
Central
Corporateheadquarters
headquarters
Corporate
Reduce remittance
time 1.5 days
Increase disbursement
time 1 day
2.5 days freed-up
cash balance
Distant
disbursement
centre
2012 McGraw-Hill Ryerson Limited
LO2
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LO3
Marketable Securities
Excess cash should be invested in short-term securities
(marketable securities).
Factors to consider in choosing these securities:
yield
maturity
minimum investment required
safety
marketability
Yield (return) on marketable securities:
100 P 365
r
P
d
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LO3
Figure 7-2
An examination of
yield and maturity
characteristics
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LO3
Table 7-3
Hierarchy of money market instruments and rates
Yield
Mar. 22,
1990
Yield Apr.
29, 2011
14.25
3.00
13.38
1.25
Investment
Maturity*
Minimum
Amount
Treasury bills
6 m.
$1,000
3 m.
Safety
Marketability
Excellent
Excellent
13.25
1.08
100,000
Good
Excellent
12.94
0.27
3 m.
100,000
Good
Fair
13.33
1.07
Bankers acceptances
3 m.
25,000
Good
Good
13.27
1.12
3 m.
25,000
Excellent
Excellent
3.18
1.01
3 m.
1,000
Excellent
Excellent
13.13
0.92
Overnight repo
Day
100,000
Excellent
Excellent
--
1.0008
Day
100,000
Excellent
Excellent
--
.9972
500
Excellent
None
10.15
1.00
Open
90
5,000
Good
None
12.75
0.50
Open
None
Excellent
None
8.75
0.00-1.25
Savings accounts
* Many of these securities can be purchased with different maturities than those indicated.
Though not marketable, these investments are highly liquid and can often be withdrawn without penalty.
Quoted yields are often for wholesale amounts above $1 million
In the summer of 1981, 3-month Treasury Bills offered yields in excess of 20%
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LO4
LO4
LO4
Figure 7-4
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7.5%
cost
7%
cost
LO4
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LO4
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LO5
Inventory Management
Inventory is divided into 3 categories:
1. Raw Materials
2. Work in Progress (WIP) or Unfinished Goods
3. Finished Goods
LO5
Seasonal Production:
producing a different amount each month (based
on the season)
inventory costs are lower
operating costs are higher
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LO5
Inventory Costs
Carrying Costs
Storage
Insurance
Financing costs
Shortages
Damages
Write-offs of
obsolete stock
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Order Costs
Purchasing
Systems
Receiving
LO5
Figure 7-4
40
Ordering costs
400
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LO5
Ordering Inventory
How much do you order at one time? Depends on:
ECONOMIC ORDERING
QUANTITY
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LO5
LO5
Ordering costs
Cost of ordering.
Cost of processing inventory into stock
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LO5
2SO
C
Where,
S = Total sales in units
O = Ordering cost for each order
C = Carrying cost per unit in dollars;
Assuming:
EOQ = 2SO = 2 X 2,000 X $8 =
C
$0.20
$32,000 = 160,000
$0.20
= 400 units
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LO5
SO + CQ
Q
2
Where,
S = Total sales in units
O = Ordering cost for each order
C = Carrying cost per unit in dollars
Q = Quantity per order
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LO5
Safety Stock
Safety Stock:
Extra inventory the firm keeps in stock in
case of unforeseen problems
Minimum level of inventory planned
Designed to minimize stock outs
Management decision based on risk of stock
out, desired level of service
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LO5
Safety Stock
Assuming that;
Average inventory = EOQ + Safety stock
2
Average inventory = 400 + 50
2
The inventory carrying costs will now increase by $50.
Carrying costs = Average inventory in units X Carrying cost
per unit
= 250 X $0.20 = $50
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LO5
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Potential Benefits
Lower carrying
costs
Automatic ordering
Fewer accounting
errors
Lower quality
control costs
Elimination of waste