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Date Posted: 16:33:51 06/20/01 Wed
Author: Charles Hodges
Subject: Re: questions from chapters 1&2
In reply to: jamie k 's message, "questions from chapters 1&2" on 06:04:08 06/15/01 Fri

I've placed my answers near the below questions.


>I had a few questions from chapts. 1&2...
>
>1. On pg. 40, item #3, the book states "if payables
>increase, the firm has received additional credit from
>its suppliers, which saved cash..." While I agree
>with this statement, isn't this usually just a
>temporary situation? Since these debts will have to
>be paid shortly, the cash is going to have to decrease
>too. Why is this an advantage?
>
Yes, it is temporary for that particular bill. However, if you deal with the same vendor, then the vendor doubling your allowed payback period for accounts payable is a permanent source of interest free money. Assume you purchased $100 each month. If the terms were net 30, then you always owed $100 (i.e. one month's worth of purchases). If the terms are net 60, then you owe $200 for the two months of purchases. This is therefore a $100 interest free loan.


>2. In your slide show for Chapter 2, you use RHS and
>LHS when talking about increases and decreases in cash
>flow. What do these acronyms stand for?
>
RHS= right hand side, LHS=left hand side. Note, that in the chapter 2 videos, these are often backwards for the viewers.


>3. The book (don't have the exact page...sorry)
>states that equity never needs to be "paid off". Can
>you comment on this and explain why?
>
Equity does not have a maturity date, whereas all other liabilities have a maturity date. Thus with debt, you eventally must repay the original principal. With equity, there is no requirment to repay the principal. Instead the Board of Directors may volentarily repay stockholders by paying a dividend.

>
>4. Perhaps we will get to this later, but why would a
>company buy back shares? Is it to raise the price of
>the outstanding shares?
>
If we do have have good projects in which to invest shareholder money, then we need to return money to shareholders. There are two basic ways to do this, pay a dividend or repurchase shares. If we pay a dividend, then all shareholders recieve money and must pay taxes on that money. If we repurchase shares, only the selling shareholders must pay taxes on the money. In addition, the tax rate on dividends is usually higher than the capital gains rate when selling shares. Thus, the usual stated reason for repurchasing shares is that it is a more tax-efficent method of returning money to share holders.

>
>5. Why is it bad for companies to keep Retained
>Earnings in a cash form? I would think that keeping
>some amount of RE in liquid assets would be beneficial
>in case the company experiences a period of financial
>difficulty in the future. What are your thoughts?
>
Equity should earn an equity like return. Historically, in the U.S., stocks average a 12% return. Cash invested in a money market fund earns about a 4% return.

In addition, an individual can invest in a money market fund as easily as a company. The reason we invest in companies is that the company can invest in projects that the individual investor cannot directly invest in.

On liquidity, a company does need to maintain a certain level of liquidity. The book is suggesting that the firm should not have an "excess" level of liquidity.

Hope this helps.



>Thanks,
>
>Jamie

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