TIME VALUE OF MONEY

HOW TO COMPUTE PRESENT VALUE?

PV = Amount x PVF

1) PVF of 1 * One time payment/collection

* Periodic payment/collection (Uneven)

2) PVF of Ordinary Annuity of 1 * Periodic payments/collection (Even)

* 1st periodic payment/collection (After 1 Period)

3) PVF of Annuity Due of 1 * Periodic payments/collection (Even)

* 1st periodic payment/collection (On the 1st Day)

HOW TO COMPUTE FUTURE VALUE?

EXAMPLE:
10,000 @ 10%, 8 years

1) FVF of 1 Click 1.10 > click multiply by > click = (# years - 1) > multiply by 10,00

2) FVF of Ordinary Annuity of 1 Click 1.10 > click multiply by > click = (# years - 1) > click minus 1, div

3) FVF of Annuity Due of 1 Click 1.10 > click multiply by > click = (# years - 1) > click minus 1, div

FUTURE VALUE OF A SINGLE AMOUNT

Future value techniques typically measure cash flows at the end of a project's life.
Future value is cash you will receive/pay at a given future date.
Compound Interest - indicate that the amount of interest earned on a given deposit has become
part of the principal at the end of the period.

Example:
If Rico places 10,000 in a savings account paying 8% compounded annually, how much will have in the
account after 5 years?

If Rico places 10,000 in a savings account paying 8% compounded quarterly, how much will have in the
account after 5 years?
 PRESENT VALUE OF A SINGLE AMOUNT
Present Value is the current peso value of a future amount of money.
Based on the idea that a peso today is worth more than a peso tomorrow.
It is the amount today that must be invested at a given rate to reach a future amount.
The discount rate is often also referred to as the opportunity cost, the discount rate, the rewuired return,
or the cost of capital.

Example:
Rico is being offered an opportunity to receive 15,000 two years from now. If he can earn 6% on his inves
what is the most he should pay now for his opportunity?

ANNUITIES
Annuities are equally-spaced cash flows of equal size.
Annuities can be either inflows or outflows.
An ordinary (deferred) annuity has cash flows that occur at the end of each period.
An annuity due has cash flows that occur at the beginning of each period.
An annuity due will always be greater than an otherwise equivalent ordinary annuity because
interest will compound for an additional period.

FUTURE VALUE OF ANNUITY

Example:
Rico is choosing which two annuities to receive. Both are 5-year 10,000 annuities; annuity A is an
ordinary annuity, and annuity B is an annuity due. If both annuities earn 7%, which annuity would
provide more cash flows to Rico?

FUTURE VALUE OF ORDINARY ANNUITY

FUTURE VALUE OF ANNUITY DUE

PRESENT VALUE OF ANNUITY

Example:
Rico wants to purchase an annuity that is to be paid today. If the annuity consists of 5,000 at the end
of each year for 5 years, what is the most that Rico should pay, considering a required rate of return of 8%
What is the most that Rico should pay, if the annuity pays at the beginning of each year?

PRESENT VALUE OF ORDINARY ANNUITY

PRESENT VALUE OF ANNUITY DUE

 PRESENT VALUE OF PERPETUITY
A perpetuity is a special kind of annuity.
With a perpetuity, the periodic annuity or cash flow stream continues forever.

Example:
How much woulf I have to deposit today in order to withdraw 10,000 each year forever if I
can earn 8% on my deposit?

MIXED STREAM

FUTURE VALUE OF A MIXED STREAM

Example:
Rico is contributing a fixed percentage of his earnings within a year in an investment earning a compound
interest of 8% every year. His investment for 5 years is shown in the table below. How much money
will Rico have after 5 years?

Computation:
PRESENT VALUE OF A MIXED STREAM
Example:
Rico is being offered an opportunity to receive the following mixed stream of cash flows over the next 5 y
If Rico must earn at least 9%, what is the most he should pay for this oportunity?

Computation:
 EXAMPLE: Interest Rate = 12%
3 years

Click 1.12 > click divided by > click = (3 times)

Click 1.12 > click divided by > click = (3 times) > click GT

Click 1.12 > click divided by > click = (3 times) > click GT > click multiply by > clck 1.12

ars - 1) > multiply by 10,000

ars - 1) > click minus 1, divided by .10 > multiply by 10,000

ars - 1) > click minus 1, divided by .10 > click multiply by 1.10 > multiply by 10,000

posit has become

w much will have in the

w much will have in the

rate, the rewuired return,

e can earn 6% on his investments,

es; annuity A is an
ich annuity would
ts of 5,000 at the end
quired rate of return of 8%?
 forever if I

ment earning a compound

w. How much money
sh flows over the next 5 years.
WORKING CAPITAL
By: Prof. Rhad Vic Estoque
For Financial Analysts: Working Capital equals CURRENT ASSET
For Accountants: Working Capital equals CURRENT ASSETS - CU

* TEMPORARY CURRENT ASSETS - such as cash, that fluctuate w

* PERMANENT CURRENT ASSETS - the portion of current assets

I. NATURE OF ASSET
Example of Growing Assets: Reasons why there is a need to INCREASE ASSET SIZE/GROWTH:
Sales is gradually increasing
* Increase in sales = Additional Investment in Inventories
* Additional Inventories = Increase in Receivables
* Increase in Receivables = Increase in Other related asse
Thus, to sustain company increase in sales, there is a ne

II. WORKING CAPITAL MANAGEMENT

OBJECTIVE: TO ACHIEVE A BALANCE BETWEEN RETURN (PROFITABILITY) AND RISK

* Price Earning Ratio between two company:

Company 1 = HIGH PER
Company 2 = LOW PER

* If you want to be PROFITABLE, you need to SACRIFICE LIQUID

* If you SACRIFICE LIQUIDITY, you are INCREASING RISK
* If you WANT TO BE LIQUID, you need to SACRIFICE PROFITAB

THREE TYPES OF WORKING CAPITAL POLICIES

* FINANCING COST IS VERY LOW = INCREASE IN OVERALL PRO

* On the other hand, exposed to HIGHER LIQUIDITY RISK
 * FINANCING COST IS VERY HIGH = DECREASE IN OVERALL PRO
* Exposed to a LOWER LIQUIDITY RISK

* short-term assets are financed with short-term liabilities

* long-term assets are funded by long-term financing sources
* the RISK IS LOWER THAN AGGRESSIVE but HIGHER THAN CO

RISK RETURN TRADE-OFF

* The greater the risk, the greater is the potential for larger returns.
* More current assets lead to greater liquidity but yield lower return (profit).
* Fixed assets earn greater returns than current assets,
* Long-term financing has less liquidity risk than short-term debt, but has higher explicit cost, hence lower ret

III. MAGEMENT OF CASH

OBJECTIVE: TO INVEST EXCESS CASH FOR A RETURN WHILE RETAINING SUFFICIENT LIQUIDITY TO SATISFY FUT

* INFLOWS should be GREATER than OUTFLOWS

collections > disbursements

Reason why to AVOID IDLE FUNDS:

* it doesn't generate profit for the company
 Transaction Motive - to sustain daily operations
Speculative Motive - taking advantage of future oportunities or
Safety/Precautionary Motive - reserve cash intended for possib
Bank Relationship Requirements - compensating balance requi

CASH CONVERSION CYCLE

THE CONCEPT OF FLOAT IN CASH MANAGEMENT

FLOAT means DELAY
* diff. between the banks balance and the balance
and the balance per book

Delay arising in collection

Delay arising in Disbursement
 TYPES OF FLOAT
1) COLLECTION FLOAT (NEGATIVE FLOAT) - book balance
2) DISBURSEMENT FLOAT (POSITIVE FLOAT) - bank balan

STRATEGIES IN CASH MANAGEMENT

TWO METHODS USE TO COMPUTE APPROPRIATE LEVEL OF CASH

SUMMARY IN MANAGING CASH:
* Important is to match the COLLECTION and DISBURSEMENTS
* You'll have sufficient cash to SUSTAIN OPERATION not to sacrifice profitability
* EXCESS CASH should be INVESTED to earn for the company

IV. MANAGEMENT OF MARKETABLE SECURITIES (MES)

REASONS FOR HOLDING MS:

1) MS serve as substitute of cash balances.
2) MS serve as a temporary investment that yields return
 3) Cash is invested in MS to meet known financial obligati
loan amortizations.

V. MANAGEMENT OF RECEIVABLES
OBJECTIVE: TO ATTAIN THE SALES LEVEL (MR = MS)
TO HAVE BOTH OPTIMAL AMOUNT OF RECEIVABLES OUTSTANDING AND OPTIMAL AMOUNT OF BA

RELAXING THE CREDIT STANDARDS

 * Increase Cash discount; Extend Discount Period,
Credit Period and Credit Limit

VI. MANAGEMENT OF INVENTORY

PROBLEM: OVERAGE OR SHORTAGE OF INVENTORY
REASONS: 1) Order from supplier not arrive on time
2) Available safety stocks is shotage or overage

OBJECTIVE: TO BALANCE THE AVAILABILITY OF INVENTORIES WITHOUT SACRIFICING RELATED COSTS

INVENTORY MANAGEMENT TECHNIQUES:
EOQ MODEL

REORDER POINT
SAFETY STOCK

* If there is a HIGH SAFETY STOCK - we will be spending o

* If there is a LOW SAFETY STOCK - we will be spending o
JUST-IN-TIME

DEFINITION OF TERMS FOR INVENTORY MODELS:

STOCKOUT COSTS are the costs of not having enough inventory
SAFETY STOCK is the minimum inventory level set to protect the compan
LEAD TIME refers to the time interval between making an order and
LEAD TIME USAGE is the quantity of goods to be used during lead time
REORDER POINT refers to the level of inventory at the time an order is ma
OPTIMUM NUMBER OF ORDERS refers to the number of orders at EOQ
OPTIMAL SAFETY STOCK refers to the level of safety stock which optimizes the tot
JUST-IN-TIME (JIT) an inventory system whereby goods are completed only a
NORMAL LEAD TIME USAGE (NLTU) Normal Lead Time x Average daily usage
MAXIMUM LEAD TIME USAGE / ROP Maximum Lead Time x Average daily usage
SAFETY STOCK (Maximum lead time - normal lead time) x Avearage daily
ROP W/O SAFETY STOCK Normal Lead Time Usage
Normal Lead Time Usage + Safety Stock ; or
ROP W/ SAFETY STOCK
Maximum Lead Time x Average Usage

VII. SHORT-TERM FINANCING MANAGEMENT

VIII. UNSECURED SOURCES

TRADE CREDIT (ACCOUNTS PAYABLE)

Considered as spontaneous financing because
goods or services on credit from supplier.
* It is a continuous source of financ
* It is more readily available than ot

COMMERCIAL BANK LOANS

Short-term business credit provided by comme
promissory note to acknowledge the amount
 * Correction: 24 not 25
* Effective Rate = 23.04%

REVOLVING CREDIT AGREEMENT

IX. SECURED SOURCES
 Capital equals CURRENT ASSETS.
al equals CURRENT ASSETS - CURRENT LIABILITIES.

S - such as cash, that fluctuate with the firm's operational needs.

S - the portion of current assets required to maintain firm's daily operations.

EASE ASSET SIZE/GROWTH:

tional Investment in Inventories

Increase in Receivables
= Increase in Other related assets to sustain the operation
increase in sales, there is a need to sustain company's asset growth

wo company:
indicates that has a better growth rate in the future

, you need to SACRIFICE LIQUIDITY

ou are INCREASING RISK
ou need to SACRIFICE PROFITABILTY but there is a LOWER RISK

W = INCREASE IN OVERALL PROFITABILITY MATURITY

CLASSIFICATION OF ASSETS
o HIGHER LIQUIDITY RISK MATCHING

TEMPORARY ASSETS CURRENT LIABILITIES

CURRENT ASSETS
 CURRENT ASSETS
PERMANENT ASSETS

NON-CURRENT
NON-CURRENT LIABILITIES
PERMANENT ASSETS
ASSETS

H = DECREASE IN OVERALL PROFITABILITY / ROI

* Permanent Asset = Lowest Balance
* Temporary Asset = Highest Balance - Lowest Balance

d with short-term liabilities

y long-term financing sources
GRESSIVE but HIGHER THAN CONSERVATIVE

er explicit cost, hence lower return.

ENT LIQUIDITY TO SATISFY FUTURE NEEDS.

R than OUTFLOWS

t for the company

daily operations
antage of future oportunities or investments
eserve cash intended for possible contingencies
s - compensating balance requirements

OBJECTIVE IN THE CONCEPT OF CASH CONVERSION CYCLE:

*The LOWER THE CCC or OC the better, it SIGNIFIES COMPANY LIQUIDITY
* NEGATIVE CASH CONVERSION CYCLE / ZERO
SHORTER Ave. Age of Inventories and Ave. Age of Receivables
LONGER Ave. Age of Trade Payables

1) sell and collect as fast as possible

2) prolong the disbursements as long as possible

SOURCES OF FLOAT:
balance and the balance 1) MAIL FLOAT
2) PROCESSING FLOAT - delay caused by Internal Control
3) CLEARING FLOAT - delay caused by Bank
EGATIVE FLOAT) - book balance > bank balance; should be MINIMIZE
(POSITIVE FLOAT) - bank balance > book balance; should be MAXIMIZE
of cash balances.
ry investment that yields return while funds are idle.
o meet known financial obligations susch as tax payments and

AND OPTIMAL AMOUNT OF BAD DEBTS

* The credit standard should not be too tight

which may eliminate the risk of non-payment,
but also eliminate potential sales to rejected
customers; neither be too loose or liberal, which
may lead to higher sales, but also higher bad debt
losses and collection costs.

* Extending Credit is a Cost-benefit Analysis

* Tolerable credit is when: MR = MC
Extend Discount Period,

ICING RELATED COSTS

 Simplied Formula for ROP:
ROP = Lead Time (Annual Usage / Working Days in a year) + Safety Stock

Normal Lead Time Usage

Y STOCK - we will be spending on Carrying Cost

Y STOCK - we will be spending on Stock out Cost
g enough inventory
level set to protect the company against delays in arrival of inventory
between making an order and its receipt
o be used during lead time
ntory at the time an order is made
rders at EOQ
y stock which optimizes the total carrying and stockout costs
eby goods are completed only as ordered by customers and materials are delivered JIT for production
age daily usage
erage daily usage
rmal lead time) x Avearage daily usage

+ Safety Stock ; or
erage Usage
 S PAYABLE)
spontaneous financing because it is automatically obtained when a firm purchases
es on credit from supplier.
s a continuous source of financing
s more readily available than other negotiated sources of short-term credit

iness credit provided by commercial banks, requiring the borrower to sign a

te to acknowledge the amount of debt, maturity and interest.
*Denominator is the NET PROCEEDS

6,000,000 x 10.5% = 630,000 Financing cost of Interest

4,000,000 x 1/2 of 1% = 20,000 Commitment Fee

630,000 + 20,000 = 650,000 Financing Cost of the loan

 MATURITY
AGGRESSIVE CONSERVATIVE
MATCHING
CURRENT LIABLITIES
CURRENT LIABILITIES
CURRENT LIABILITIES

NON-CURRENT
LIABILITIES
 CURRENT LIABILITIES

NON-CURRENT
NON-CURRENT LIABILITIES
LIABILITIES NON-CURRENT
LIABILITIES

west Balance
THEORIES (WORKING CAPITAL MANAGEMENT)

1) Net working capital is the difference between current assets and urrent liabilities
* The stockholder's equity is not a component of working capital
* Quick assets do not include all the current assets
* Working capital is a measure of short-term solvency

2) Working capital management is the administration of the company's working capital. The primary objective
a balance between risk and return (profitability)

3) In a Conservative (relaxed or moderate) working capital financing policy, operations are operated with too
almost all asset investments with long-term capital/liabilities. Although it reduces the company's risk of liqu
exposure to fluctuating loan rates, it is less profitable because it requires higher financing costs.

Financing Inventory with long-term debt increases the current ratio. Although the borrowing costs is higher,

A conservative working capital policy minimizes the risk of illiquidity by increasing working capital. It is cha
higher acid-test ratio because assets are financed using long-term or permanent funds rather than short-term
* Short-term debt is usually less expensive than long-term debt
* Liquid assets do not ordinarily earn higher returns relative to long-term assets, so holding the forme
* Capital structure and dividends relate to capital structure finance not working capital structure.

4) The hedging (self-liquidating or matching) policy matches maturities of debt with specific financing needs. S
short-term liabilities, long-term assets are funded by long-term financing sources.

5) Risk-return trade-off - profitabilty (return) varies inversely with liquidity. Higher liquidity leads to lower risk a

6) Cash coversion cycle ( or operating cash conversion cycle or cash flow cycle) is the length of time it takes for
to be realized as cash inflows from sales

7) Cash Management involves the maintenance of the appropriate levels of cash and investment in marketable
and to maximize income on idle funds. One of its objectives is to invest excess cash for a return while retain

8) Compensating balance is a certain percentage of the face amount of loan which the bank requires its borrow
* This amount compensates the bank for the services rendered to the borrower.
* It increases the effective rate of interest paid by the borrower.
* It can be used by the bank to satisfy its reserve requirement.
* It can be relent to other borrowers, thereby resulting in greater profitability of the bank

9) Payment by draft is a means of slowing cash outflows

* A draft is a three-party instrument in which the drawer orders the drawee to pay money to the paye
is made by a check, a check float or clearing float arises, which slows down the actual outflow of cash.
* Electronic Data Interchange (EDI) and cash receipts. Fund Transfer (AFT) are techniques used to acc
* The Baumol cash Management Model is an EOQ-type model which can be used to determine the o
 maintaining cash are at the minimum.

10) When the credit term granted by the seller is longer than the buyer's operating cycle, the seller is, in effect,
* A seller that grants longer credit terms will have a higher level of accounts receivables than those c
* A seller cannot be sure if its buyer will be able to convert its inventories into cash

11) The average collection period is computed by dividing the average accounts receivable by the average sales
Accordingly, the change in credit policy caused an increase in the investment in accounts receivable and a d
Both of these changes increased the average collection period.
* Discounts taken decreased. So, the rate of discount offered couldn’t have increased.

12) Projected Net Income includes non-cash items in its computation. Depreciation expense is a non-cash item. A
include only cash items, both cash inflows and outflows.

13) Cash and Marketable securuties are held because of their ability to facilitate routine operations of the comp
In dealing with these highly liquid assets, the corporate treasurer is primarily concerned with the firm's liqui

14) Accounts Receivable management involves the formulation and administration of plans and policies related
at a predetermined level and their collectibility as planned. Its objective is to have both the optimal amount
This balance requires trade-off between:
* the benefit of more credit sales, and
* the costs of accounts receivable such as collection, interest, and bad debts cost
pital. The primary objective is to achieve

ons are operated with too much working capital. It involves financing
s the company's risk of liquidity and eliminates the firm's
financing costs.

borrowing costs is higher, liquidity is greater and risk is lower.

ng working capital. It is characterized by a higher current ratio and

funds rather than short-term sources.

assets, so holding the former wil not maximize the return on total assets
orking capital structure.

h specific financing needs. Short-term asstes are financed with

quidity leads to lower risk and lower return.

he length of time it takes for the initial cash outflows for goods and services

d investment in marketable securities to meet the firm's cash requirements

sh for a return while retaining sufficient liquidity to satisfy future needs.

he bank requires its borrowers to keep in a non-interest bearing current account.

bility of the bank

e to pay money to the payee. A check is the most common draft. When payment
the actual outflow of cash.
) are techniques used to accelarate
be used to determine the optimal cash balance, where the costs of obtaining and
ycle, the seller is, in effect, financing more than the compny's inventory needs.
ts receivables than those companies granting shorter credit terms

vable by the average sales per day.

ccounts receivable and a decrease in sales.

e increased.

xpense is a non-cash item. A cash budget prepared in the most direct way should

tine operations of the company, not for the purposes of achieving investment returns.
cerned with the firm's liquidity and safety.

f plans and policies related to sales on account and ensuring the maintenance of receivable s
e both the optimal amount of receivables outstanding and the optimal amount of bad debts.