You work in the treasury department of a manufacturing company and have been tasked to prepare a short-term financial plan for the coming year. The projected sales forecasts for the next five quarters are, respectively, $210m, $180m, $245m, $280m, and $240m. The firm sells on credit and takes, on average, 30 days to collect from its customers; $68m in receivables are currently outstanding. Also, the firm orders a quarter in advance on credit—purchases in a given quarter is 60% of next quarter’s sales and the firm typically takes 50 days to pay its suppliers. Quarterly selling, general, and administrative expenses are estimated to be 25% of corresponding quarterly sales, and the firm expects to pay quarterly dividends of $12m. The purchasing manager plans to acquire a high-performance machine in the second quarter for $160m.
The firm would like to maintain a consistent cash balance of $10m in a non-interest bearing bank account. Although it currently has $64m in cash, it would like to redirect excess cash to short-term money market investments. Shortfalls, should they occur, are to be financed to achieve the target cash balance as well. 90-day commercial paper with a face value of $100,000 is selling at $98,814 and Treasury bills of a similar maturity are selling at 99.11% of par value; yields of both instruments are expected to remain stable over time. The firm has a $400m line of credit with a quoted quarterly rate of 1.6% and a compensating balance of 5%, which should be sufficient for its short-term financing needs. However, it also has the option to factor its receivables at a 1.5% discount.
(a) Compare the yields on the 90-day commercial paper and Treasury bill. In which money market instrument should the firm invest its cash surpluses, assuming yield is the only consideration?
Yeild in % | |||||
90 days commercial Paper | =100000-98814 | 1186 | 4.800939138 | =(1186/98814)*(360/90)*100 | |
Treasury Bill yield | =100000-99110 | 890 | 3.59196852 | =(890/99110)*(360/90)*100 | |
Since 90 days commercial Paper is giving better yield, the firm should invest in it. | |||||
However, one should also keep in mind that interest or yield received on 90 days commercial paper is not | |||||
tax exempt, where as treasury bill yield is tax exempt. So, eventually it may so happen that treasury bill | |||||
is giving more yeild than commercial paper | |||||
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