Question 1: Answer all parts A. Describe the cash conversion cycle. How can a co
ID: 2809957 • Letter: Q
Question
Question 1: Answer all parts A. Describe the cash conversion cycle. How can a company CFO use this to manage (5 marks) working capital requirements? B. Evaluate the financing tools that are available to a company CFO to fund short and medium term financing gaps. What are the advantages and disadvantages of each? (15 marks) C. You are the CFO of a company and are offered a discount of 3% on an invoice of 500,000 for payment within 10 days. Your alternative is to take 60 days credit and fund this through an overdraft with an annual cost of 15%. Which option would you (10 marks) choose? D. What kinds of restrictive covenants might a bank attach to a term loan? What is the (10 marks) purpose of these? E. A lower Debt Service Coverage Ratio (DSCR) wil result in a lower IRR to equity (10 marks) investors. Discuss.Explanation / Answer
A. cash converison cycle = days inventory outstanding + days sales outstanding - days payables outstanding.
It is a formula in management, which determines that how effectively a company manages it's working capiatl requirements.A longer CCC means a company is taking longer time to generate cash ,it happens when a company has a lot of inventory in hand, receives accounts receivable slowly and pays expenses quickly. If a company is in urgent need for cash,they would collect the receievables quickly and try and convert inventory into cash as soon as possible.
B. Short term financing needs :
Customer advances : some companies take advances from customers before the large orders they place. This helps the companies channelize some funds into the business for fulfilling those orders.
bank overdraft : cutomers of current account are allowed to withdraw a sum of money beyond the amount actually held in bank balances.
disadvantages: interest will be charged.
selling goods on installment :some customers may find it difficult to make large payments on the goods purchased by them.In such cases , making smaller payments ensure that the company would not have to wait for the payments at the end and smaller payments ensure that there is constant flow of funds running into the business and it does not choke up the accounts recieveble.
medium term:
public deposits: companies accepts deposits from members, general public and directors.
disadvantages : it is an uncertain and unrelaible source.
advantages: there is no legal formalities, it is less costly than taking loans from banks.
medium term loans :when the business is in the need of huge funds they may also borrow medium term loans from banks
disadvantage : mortgaging of assets is required,and the rate of interest is high.
advantages : the interest paid on banks provide tax exemption. there is minimum floatation costs.
C. the cost of not taking the discount would be :
3%/97% * 360/ 60 - 10
=0.0309 * 7.2
=22.248 %
if you are not taking the discount by making the making the payment within 10 days and not waiting till the 60days creidt period , the cost of this would be 22.25%
amd instead of you wait for 60 days, with an overdraft you would be charged with just a15% annual cost , so we are taking thsi option as the costs of taking this option is low.
D. the kinds of restrictive covenants attached to a term loan are :
the purpose of such covennats is putting the interest of the lender, in this case the banks in term loan agreements. As these covennats will restrict the borrower from doing certain things.
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.