Page 144 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 8: Cash Planning

 The firm may historically have collected an average of a certain percent of its outstanding Notes
receivables from a particular period in another particular period, but this average contains
considerable variability.
 Further, changing market and economic conditions may make for chancy extrapolation of
post historic data into future period.

 A very common mistake regarding futures contracts is to think of the margin requirement
as an out-of-pocket transaction cost.
 Like a deposit on any purchase contract, the margin is eventually applied to the purchase
pries should the buyer take delivery.
 If the buyer cancels the contract by taking an opposing position the margin is returned to
the trader (less any losses and plus any gains).
 Thus, the margin requirement is a partial payment for the final goods, not a transaction
cost.

8.7 Keywords

Operating Cycle: The operating cycle of firm begins with the acquisition of raw materials and
ends with the collection of receivables.

Opportunity Cost: The rate of return that can be earned on the best alternative investment.
Portfolio: A combination of assets.

8.8 Review Questions

1. Why should a financial manager focus on cash flow rather than earnings?
2. S.B. Mukherjee is considering the acquisition of personal computer and associated software
to improve the efficiency of its inventory and accounts receivable management. Mukherjee
estimates that the initiate cash outflow for the computer and software will be ` 1,50,000
and the associated net cash savings will be ` 30,000 annually.
(a) If Mukherjee’s discount rate for the cash flows associated with the project is 12 per
cent and ` 30,000 savings will occur for only ten years (at which time the computer
and software will be valueless), should he buy the computer?
(b) What if the project last ten years but the discount rate is 16 per cent?
(c) What if the project lasts forever and the discount rat is 12 per cent?

(d) What if the project last forever and the discount is 16 per cent?
3. Why is it useful to separate major cash flows from minor ones in daily cash forecasting?
4. Why do corporations put so much emphasis on cash forecasts? What would happen if a
company continually relied on inaccurate cash forecasts?
5. How can a company’s cash position be measured for forecasting purposes? Why do
manager generally prefer using the available bank balance?

6. R.D. Vasu, manager of the Royal Sports Club, is considering lowering the usage fee for the
play ground. He estimates that this will result in an immediate (one-time) cash flow of
` 18, 00,000 from new membership fees. On the other hand, the annual net cash flow from
usage fees is expected to fall by ` 3, 00,000 indefinitely (because of the lower fees).

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