Cash Management Strategies Quiz

Questions and Answers

Which THREE of the following are reasons for holding cash?

Investment motive

Precautionary motive (correct)

Movement motive (correct)

Transactions motive (correct)

Which action would be most appropriate to utilize a short-term surplus in cash budget?

Increase payables by delaying payment to suppliers

Invest in a long-term deposit bank account (correct)

Buy back the company’s shares (correct)

Pay suppliers earlier to take advantage of any prompt payment discounts (correct)

According to the Baumol Model, what is the optimum amount of short-term investments to convert into cash in each transaction if a company needs $150,000 annually?

$54,772 (correct)

$38,730

$63,246

$48,990

When a company’s transaction costs of converting investments to cash decrease and the interest rate increases, what should happen to the optimal cash holding?

Optimal cash holding is increased by 50% Signup and view all the answers

In the Miller-Orr model, when the cash balance rises above the upper limit, what action is taken?

Buy short-term securities Signup and view all the answers

What level of cash receipts should be recorded in the cash budget for March 20X2 given the sales forecast and payment patterns?

$200,400 Signup and view all the answers

Which THREE of the following items should be included in a cash flow forecast?

Interest paid on loans Signup and view all the answers

What should happen when the cash balance falls to the lowest limit in the Miller-Orr model?

Sell securities to raise cash Signup and view all the answers

Which statement accurately reflects the characteristics of convertible secured loan notes compared to ordinary secured loan notes?

Likely to be more expensive to service because of their equity component Signup and view all the answers

What type of capital do preference shares represent, and what is their risk level compared to ordinary shares?

Equity capital that carries a lower risk than ordinary shares Signup and view all the answers

Calculate the theoretical ex-rights price per share if the EPS is currently $0.50 and the shares are trading on a price/earnings ratio of 20 times.

$9.00 Signup and view all the answers

What does a rights issue typically provide to existing shareholders?

An opportunity to purchase additional shares at a fixed price Signup and view all the answers

In regards to Islamic finance, what accurately reflects the murabaha and mudaraba structures?

Murabaha can provide financing needs while mudaraba involves managing partnerships Signup and view all the answers

What is the theoretical value of a right per existing share for a company with $5m of $0.50 nominal value ordinary shares, if the rights issue is at $6 per share?

$0.40 Signup and view all the answers

Which statement generally describes a sukuk?

Similar to bonds but conforming to Islamic law Signup and view all the answers

When considering the benefits of a flexible repayment schedule, which of the following is a potential drawback with traditional loan structures?

Repayment terms are inflexible and fixed Signup and view all the answers

What is the primary characteristic of a bond in Islamic finance?

The lender shares in the risks and rewards of ownership. Signup and view all the answers

Which of the following is considered a funding gap for small and medium-sized enterprises (SMEs)?

The difference between required and obtained capital. Signup and view all the answers

Which option describes the concept of 'venture capital' in the context of SMEs?

Private equity investments focused on startup companies. Signup and view all the answers

What is the common reason SMEs have restricted access to capital markets?

Lack of sufficient financial disclosure. Signup and view all the answers

When private individuals invest directly into a small business, what is this process called?

Business angel financing Signup and view all the answers

Which statement accurately reflects the challenges faced by SMEs in relation to funding?

Many SMEs are viewed as higher-risk investments. Signup and view all the answers

Which of the following statements about SMEs is true?

Medium term loans are often harder to obtain than longer term loans. Signup and view all the answers

What is a common misconception about funding for SMEs?

Founding shareholders must sacrifice limited liability to access loans. Signup and view all the answers

What is the suitable risk-adjusted cost of equity for the new project calculated using the capital asset pricing model?

13.0% Signup and view all the answers

What is the net asset value per share of QK Co on a historic basis?

$0.73 Signup and view all the answers

What is the total net realizable value for the assets of the private company?

$36m Signup and view all the answers

In which situation is asset-based business valuation using net realizable values most useful?

When determining a minimum threshold price in a liquidation Signup and view all the answers

Which definition best describes replacement value of a business?

Cost of acquiring similar assets Signup and view all the answers

What is the debt to equity ratio (debt/debt + equity) given the average debt of 25%?

50% Signup and view all the answers

How is the capital asset pricing model primarily used in finance?

To assess investment risk and returns Signup and view all the answers

What factor is NOT considered in calculating the minimum price per share for the private company?

Future earnings potential Signup and view all the answers

What is the expected six-month forward exchange rate according to interest rate parity?

€1·499 per $1 Signup and view all the answers

What type of risk is primarily faced by Herd Co regarding its euro receipt?

Transaction risk Signup and view all the answers

Which hedging method is NOT suitable for Herd Co to hedge its euro receipt?

Currency swap Signup and view all the answers

What statement supports the finance director's belief that the euro will depreciate against the dollar?

The dollar inflation rate is higher than the euro inflation rate Signup and view all the answers

Which statement is correct regarding the interest rate risk faced by Herd Co?

Buying a floor protects against interest rate decreases Signup and view all the answers

If Herd Co believes interest rates will rise, what action might they consider to mitigate risk?

Engaging in a forward rate agreement Signup and view all the answers

Which factor is least likely to influence Herd Co's decision to hedge its foreign receipt?

Historical interest rates Signup and view all the answers

What describes the relationship between LIBOR and the variable interest paid on Herd Co's loan notes?

The interest paid on the loan notes is contingent on LIBOR fluctuations Signup and view all the answers

Study Notes

Cash Management and Business Finance

Holding cash is essential for businesses to meet immediate needs despite investing it for returns.
Reasons for holding cash include:
- Movement motive: Cash to manage fluctuations in cash flow.
- Transactions motive: Cash needed for day-to-day operations and expenditures.
- Precautionary motive: Cash reserve to cover unforeseen expenses.

Thrifty Pic’s Cash Budget

A projected short-term cash surplus can be utilized effectively through:
- Paying suppliers earlier for discounts.
- Investing in long-term deposit accounts for better returns.

Baumol Model Calculations

A company requiring $150,000 annually, incurs $400 transaction costs converting investments to cash, with interest rates of 5% on investments and 1% on cash.
Optimal amount to convert per transaction is determined to manage costs and maximize returns.

Miller-Orr Model Application

TB Co's treasury management identifies:
- A minimum cash balance of $1 million and maximum of $10 million.
- Actions when reaching these thresholds include transferring excess cash into securities and selling portions when falling below lower limits.
- Variance in daily cash flows affects the cash balance limits.

Sales Receipts Calculation

JP Co’s sales in January, February, March, and April span over $300,100 to $320,500, with half being credit sales.
An estimated percentage of receivables can result in significant early settlement discounts, affecting cash budget totals in March.

Cash Flow Forecasting Essentials

Key items to consider include:
- Flexible repayment schedules.
- Charges only for drawn amounts.
- Consideration of lower interest rates for budgeting.

Convertible Secured Loan Notes

Generally more expensive to service due to their equity aspect, contrasting with ordinary secured notes.

Preference Shares

Represent equity capital, carrying lower risk than ordinary shares.

Rights Issue Pricing

A 1 for 4 rights issue and current EPS of $0.50 with a market cap of $50 million lead to discernible changes in share price and theoretical ex-rights price.

Islamic Finance Options

Tulip Co's financing needs can be met through:
- Murabaha: Financing product in Islamic finance for asset purchase.
- Mudaraba: Partnership between an investing and working partner.

Sukuk Characteristics

Defined as a bond in Islamic finance where the lender possesses the asset and shares associated risks.

SMEs and Funding Challenges

Young SMEs face barriers in accessing finance, illustrated by:
- High perceived risk by lenders.
- Lack of detailed financial reports.
- Inability to privately place shares.

Funding Gap in SMEs

Defined as the difference between required and available capital, evidenced by higher perceived risks compared to larger entities.

Business Valuation Strategies

Different assessment methods, including asset-based valuation for strategic acquisitions and the replacement value reflecting necessary cost structures.

Interest Rate Risk Management

Companies like Herd Co manage risks tied to currency depreciation and rising interest rates through various hedging techniques and understanding market dynamics.

Forward Exchange Rates and Risk Classification

Predictive measures for forward exchange rates utilizing interest rate parity indicate economic conditions affecting transaction risks for international receipts.

Interest Rate Risk Hedging

Options such as interest rate futures and options provide means to mitigate potential risks associated with variable rate loans, lending strategic foresight to treasury management.

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Description

This quiz covers essential reasons for holding cash in a business context, including movement, transactions, and precautionary motives. Additionally, it explores appropriate actions to take when a company has a short-term cash surplus. Test your knowledge on effective cash management strategies.