CASH AND LIQUIDITY MANAGEMENT
LO1 The importance of float and how it affects the cash balances.
LO2 How firms manage their cash and some of the collection, concentration, and disbursement techniques used.
LO3 The advantages and disadvantages to holding cash and some of the ways to invest idle cash.
Answers to Concepts Review and Critical Thinking Questions
2. (LO3) If it has too much cash it can simply pay a dividend, or, more likely in the current financial
environment, buy back stock. It can also reduce debt. If it has insufficient cash, then it must either borrow, sell
stock, or improve profitability.
4. (LO3) It is debatable whether holding enormous cash reserves is the best way to deal with future economic
downturns. However, it is true that auto manufacturers’ operating cash flows are very sensitive to the business
cycle, and enormous losses have occurred during recent downturns.
6. (LO3) Such instruments go by a variety of names, but the key feature is that the dividend adjusts, keeping the
price relatively stable. This price stability, along with the dividend tax exemption, makes so-called adjustable
rate preferred stock very attractive relative to interest-bearing instruments.
a. About the only disadvantage to holding T-bills are the generally lower yields compared to alternative
money market investments.
b. Some ordinary preferred stock issues pose both credit and price risks that are not consistent with most
short-term cash management plans.
c. The primary disadvantage of CDs is the normally large transactions sizes, which may not be feasible for
the short-term investment plans of many smaller to medium-sized corporations.
d. The primary disadvantages of the commercial paper market are the higher default risk characteristics of
the security, and the lack of an active secondary market which may excessively restrict the flexibility of
corporations to meet their liquidity adjustment needs.
e. If interest rates rise, the bond drops in price.
10. (LO3) A potential advantage is that the quicker payment often means a better price. The disadvantage is that
doing so increases the firm’s cash cycle.
Solutions to Questions and Problems
NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple steps. Due to
space and readability constraints, when these intermediate steps are included in this solutions manual, rounding
may appear to have occurred. However, the final answer for each problem is found without rounding during any
step in the problem.
a. The disbursement float is the average monthly checks written times the average number of days for the
checks to clear, so:
Disbursement float = 4($14,000)
Disbursement float = $56,000
S19-1 The collection float is the average monthly checks received times the average number of days for the
checks to clear, so:
Collection float = 2(–$26,000)
Collection float = –$52,000
The net float is the disbursement float plus the collection float, so:
Net float = $56,000 – 52,000
Net float = $4,000
b. The new collection float will be:
Collection float = 1(–$26,000)
Collection float = –$26,000
And the new net float will be:
Net float = $56,000 – 26,000
Net float = $30,000
a. The collection float is the average daily checks received times the average number of days for the checks
to clear, so:
Collection float = 3($19,000)
Collection float = $57,000
b. The firm should pay no more than the amount of the float, or $57,000, to eliminate the float.
c. The maximum daily charge the firm should be willing to pay is the collection float times the daily
interest rate, so:
Maximum daily charge = $57,000(.00019)
Maximum daily charge = $10.83
a. Total float = 4($17,000) + 5($6,000)
Total float = $98,000
b. The average daily float is the total float divided by the number of days in a month. Assuming 30 days in
a month, the average daily float is:
Average daily float = $98,000/30
Average daily float = $3,266.67
c. The average daily receipts are the average daily checks received divided by the number of days in a
month. Assuming a 30 day month:
Average daily receipts = ($17,000 + 6,000)/30
Average daily receipts = $766.67
The weighted average delay is the sum of the days to clear a check, times the amount of the check
divided by the average daily receipts, so:
S19-2 Weighted average delay = 4($17,000/$23,000) + 5($6,000/$23,000)
Weighted average delay = 4.26 days
5. (LO2) The average daily collections are the number of checks received times the average value of a check, so:
Average daily collections = $108(8,500)
Average daily collections = $918,000
The present value of the lockbox service is the average daily receipts times the number of days the collection is
PV = (2 day reduction)($918,000)
PV = $1,836,000
The daily cost is a perpetuity. The present value of the cost is the daily cost divided by the daily interest rate.
PV of cost = $225/.00016
PV of cost = $1,406,250
The firm should take the lockbox service. The NPV of the lockbox is the cost plus the present value of the
reduction in collection time, so:
NPV = –$1,406,250 + 1,836,000
NPV = $429,750
The annual savings excluding the cost would be the future value of the savings minus the costs, so:
Annual savings = $1,836,000(1.00016) – 1,836,000
Annual savings = $110,406.05
And the annual cost would be the future value of the daily cost, which is an annuity, so:
Annual cost = $225(FVIFA 365,.016%
Annual cost = $84,563.46
So, the annual net savings would be:
Annual net savings = $110,406.05 – 84,563.46
Annual net savings = $25,842.59
a. The average daily float is the sum of the percentage each check amount is of the total checks received
times the number of checks received times the amount of the check times the number of days until the
check clears, divided by the number of days in a month. Assuming a 30 day month, we get:
Average daily float = [.60(5,300)($55)(2) + .40(5,300)($80)(3)]/30
Average daily float = $28,620
On average, there