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Working Capital Management
Notes 9.5.1 Holding a Stock of Extra Cash
We refer here to a stock of cash kept by the firm beyond that needed for transactions. Cash is the
most flexible but the most costly hedge available to the firm. It is the most flexible in that it can
hedge a shortage in any circumstances, at any time, with no transaction costs. If the firm holds a
stock of extra the temporary investment. Interest rate futures and options can also be used to
hedge interest rate risks that do not arise as the result of uncertainties in the firm’s cash flow, but
instead occur solely because of changing interest rates between the time of the forecast and the
planned investment of financing.
Illustration 1: Global Recreation Centers is attempting to forecast cash receipts from its Eastern
Division. Cash is deposited into two field banks on a daily basis. The cash manager has found
that deposits follow a fairly strong day-of-week pattern. She used historical data to determine
the fraction of each week’s total revenues deposited by day-of-week by district. Combined with
weekly revenue estimates the fractions help her estimate daily deposits from Eastern Division.
The parameters obtained from the past 3 months’ deposit data follow:
Day of Week District 1 using Deposit Bank 1 District 2 using Deposit Bank 2
Monday 36.0 % 31.0%
Tuesday 13.0 15.0
Wednesday 17.0 17.0
Thursday 15.0 20.0
Friday 19.0 17.0
100.0% 100.0%
Weekly revenue estimates from the sales department were also obtained:
Day of Week District 1 District 2
Week 1 ` 68,000 ` 52,000
Week 2 ` 39,000 ` 44,000
Solution:
To forecast daily deposits into each bank, we simply multiply the weekly revenue by the day-of-
week percentage and sum across the two districts.
Table 9.1
Total
District 1 (Bank 1) District 2 (Bank 2)
Daily
Day Fraction TOT/Week Daily Fraction TOT/Week Daily Deposit
Mon 36.0 ` 68,000 ` 24,480 31.0% ` 39,000 ` 12,090 ` 36,570
Tue 13.0 68,000 8,840 15.0 39,000 5,850 14,690
Wed 17.0 68,000 11,560 17.0 39,000 6,630 18,190
Thu 15.0 68,000 10,200 20.0 39,000 7,800 18,000
Fri 19.0 68,000 12,920 17.0 39,000 6,630 19,550
Mon 36.0 52,000 18,720 31.0 44,000 13,640 32,360
Tue 13.0 52,000 6,760 15.0 44,000 6,600 13,360
Wed 17.0 52,000 8,840 17.0 44,000 7,480 16,320
Thu 15.0 52,000 7,800 20.0 44,000 8,800 16,600
Fri 19.0 52,000 9,880 17.0 44,000 7,480 17,360
Total ` 1,20,000 ` 1,20,000 ` 83,000 ` 83,000 ` 2,03,000
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