allowance for “safety stock.” It also assumes discrete, certain cash flows. The Miller-Orr model improves the understanding of the problem by determining the relationships among the different variables, but it neglects other factors that affect the target cash balance.
28.3 · Describe collection and disbursement float.
Collection float is the time that elapses from the moment the customer mails the payment until cash is received. Disbursement float is the time that elapses from the moment a company mails a check and the time cash is withdrawn from the company’s bank account.
· What are lockboxes? Concentration banks? Wire transfers? Lockboxes are postal boxes strategically located in such a way that the mailing time from customers to the box is minimized. The firm’s bank has direct access to the boxes, and thus in-house handling is eliminated and collection float is reduced. Concentration banks are regional banks in which the company has accounts and to which it sends excess cash at the end of the day. In this fashion checks obtained from nearby customers can be collected daily. Wire transfers are electronic transfers of surplus funds from local deposit banks to concentration banks.
· Suppose an overzealous financial manager writes checks on uncollected
funds. Aside from legal issues, who is the financial loser in this situation?
The bank where the firm has its accounts.
· Why do firms find themselves with idle cash?
To finance seasonal or cyclical activities (transactions motive), to finance planned expenditures (investment motive), and to provide for unanticipated contingencies (precautionary motive).
· What are the types of money market securities? 1. U.S. Treasury bills and 2. Federal agency securities 3. Municipal securities 4. Commercial paper 5. Certificates of deposit
6. Repurchase agreements
7. Eurodollar certificates of deposit 8. Bankers’ acceptances
CONCEPT QUESTIONS - CHAPTER 29
29.1 · What considerations enter into the determination of the terms of sale?
1. Probability of non-payment 2. Size of the account 3. Perishability of goods
4. Industry standards and competition 5. Standard speed of collection 6. Price of the goods
29.2 · List the factors that influence the decision to grant credit. 1. The delayed revenues from granting credit 2. The immediate cost of granting credit 3. The probability of non-payment
4. The appropriate required rate of return for delayed cash flows.
29.4 · What is credit analysis?
It is the process of trng to determine the probability that a customer will default. It involves:
a. gathering relevant information, and b. determining creditworthiness
· What are the five Cs of credit?
Character, capacity, capital, collateral, conditions.
29.5 · What tools can a manager use to analyze a collection policy? Average collection period, the aging schedule, and the payments pattern.
CONCEPT QUESTIONS - CHAPTER 30
30.1 · What is a merger? How does a merger differ from other forms of acquisition?
A merger is the absorption of one firm by another, where the acquiring firm retains its identity and the acquired firm ceases to exist. It differs from other forms of acquisition in that no new firm is created, and there is no need of bung the individual assets of the acquired firm or
its stock.
· What is a takeover?
It is the transference of control of a firm from one group of
shareholders to another by means of a majority vote of the board of directors.
30.3 · What is the difference between purchase accounting and pooling-of-interest accounting.
The most important difference is the creation of goodwill for a purchase.
30.8 · Why can a merger create the appearance of earnings growth? If a high price-earnings ratio company acquires a low price-earnings company, the market might assume that the price-earnings ratio does not change.
30.9 · In an efficient market with no tax effects, should an acquiring firm use cash or stock?
It would not matter because the NPV of the acquisition will be zero, and so the acquired firm's shareholders obtain nothing but the value of the stock. If they use cash, the value of the acquired firm's stockholders is the same as the value of the original firm.
30.10 · What can a firm do to make a takeover less likely? 1. It can change the corporate charter by requiring a higher
percentage of share approval for a merger or staggering the election of board members.
2. It can engage in standstill agreements (greenmail). 3. It can make an exclusionary self-tender
4. It can provide golden parachutes to top executives 5. It can sell major assets, i.e., the \6. It can use \
30.11 · What does the evidence say about the benefits of mergers and acquisitions?
It says that they usually benefit the shareholders of the acquired firm but do not significantly affect the shareholders of the acquiring firm. In terms of the new entity, a monopoly power can be created.
30.12 · Can you describe a Keiretsu?
Networks of Japanese firms usually affiliated around a large bank, industrial firm, or trading firm.
· What is a benefit of Keiretsu?
To reduce the costs of financial distress.
the firm is forced to take corrective action.
· What are stock based insolvency and flow based insolvency? Stock based insolvency occurs when a firm has negative net worth. Flow based insolvency occurs when a firm has a short fall in cash flow.
31.2 · Why doesn't financial distress always cause firms to die? Financial restructuring may make a firm worth more\dead\
· What is a benefit of financial distress?
It can serve as an early warning system or \
31.3 · What is bankruptcy?
Legal bankruptcy occurs when a firm files for bankruptcy under chapter 7 (liquidations) or chapter 11 (reorganization). 1 the Bankruptcy Reform Act, 1978.
· What is the difference between liquidation and reorganization? Liquidation occurs when the assets of a firm are sold and payments are made to creditors (usually based upon the APR). Reorganization is the restricting of the firm's finances.
31.4 · What are two ways a firm can restructure its finances? Private workouts may be more expensive because of complex capital structure or conflicts of interest.
· Why do firms use formal bankruptcy? Equity holdouts
Private workouts may be more expensive because of complex capital structure or conflicts of interest.
31.5 · What is a prepackaged bankruptcy?
A situation where the firm and most of all creditors agree to a private
reorganization before bankruptcy takes place. After the private agreement, the firm files for formal bankruptcy.
· What is the main benefit of prepackaged bankruptcy? Revco's complicated capital structure.
· What are some of the costs of the Revco D.S. Bankruptcy? The direct and indirect costs of financial distress indicating a costly change in management and structural direction.
CONCEPT QUESTIONS - CHAPTER 32
32.1 · What is the difference between a Eurobond and a foreign bond?
A Eurobond is issued by a foreign country, denominated in the currency of its country of origin and sold in a different country. A foreign bond is denominated in the currency of the country in which it is sold, although it is issued by a company from another country.
32.3 · What is the law of one price? What is purchasing-power parity?
The law of one price is the simplest version of PPP. It states that a commodity will cost the same regardless of what currency is used to purchase it. PPP says that different currencies represent different purchasing powers, and the exchange rate adjusts to keep the purchasing power constant.
· What is the relationship between inflation and exchange-rate movements?
This relationship is called \states that the rate of inflation in one country relative to the inflation rate in another country determines the rate of change of the exchange rate of the currencies of the two countries.
32.4 · What is the interest-rate-parity theorem?
It is a theorem that implies that if interest rates are higher in one country than another, the latter country's currency will sell at a premium in the forward market. In this way money earns the same regardless of what currency it is invested in.
· Why is the forward rate related to the expected future spot rate? The trading in forward rates is based on what traders expect the spot rate to be in the future. If the expectation for the spot rate is $X/DM
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