335 of 567
y y y p y q y y y
Dynamic’s cash budget defines its problem. Its financial manager must find short-term financing to cover the firm’s forecast cash requirements. There are
dozens of sources of short-term financing, but, for simplicity, we will assume that Dynamic has just two options:
1. Bank loan. Dynamic has an existing arrangement with its bank, allowing it to borrow up to $100 million at an interest rate of 10% per year, or 2.5% per
quarter. It can borrow and repay the loan whenever it chooses, but the company may not exceed its credit limit. BETA
2. Stretching payables. Dynamic can also raise capital by putting off payment of its bills. The financial manager believes that Dynamic can defer up to $100
million in each quarter. Thus, $100 million can be saved in the first quarter by not paying bills in that quarter. (Note that the cash-flow forecasts in
Table 30.5 assumed that these bills will be paid in the first quarter.) If deferred, these payments must be made in the second quarter, but up to $100
million of the second quarter bills can be deferred to the third quarter, and so on.
Stretching payables is often costly, even if no ill will is incurred.11 The reason is that suppliers may offer discounts for prompt payment. Dynamic loses this
discount if it pays late. In this example, we assume the lost discount is 5% of the amount deferred. In other words, if a $100 payment is delayed, the firm must
pay $105 in the next quarter. This is similar to borrowing at a quarterly interest rate of 5%, or equivalently at an annualized rate over 20% (more precisely,
1.054 − 1 = 0.216, or 21.6%).
Dynamic Mattress’s Financing Plan
With these two options, the short-term financing strategy is obvious. Use the bank loan first, if necessary up to the $100 million limit. If there is still a
shortage of cash, stretch payables.
Table 30.6 shows the resulting plan. In the first quarter of 2022, the plan calls for borrowing the full amount from the bank ($100 million) and stretching
$10.6 million of payables (see lines 1 and 2 of Panel B). In addition, the company sells the $25 million of marketable securities it held at the end of 2021.
Thus, it raises $100 + $10.6 + $25 = $135.6 million of cash in the first quarter (see the last line of Panel B).
In the second quarter, Dynamic needs to raise an additional $72.6 million to support its operations. It also owes interest of $2.5 million on its bank Page 867
loan and must retire the payables that it stretched last quarter. With the 5% penalty for late payment to suppliers, this adds $10.6 + $0.5 million to the funds
it must raise in the second quarter. Finally, to compensate for the interest it had been earning on the securities it sold in the first quarter, it will require
another $0.50 million. In total, therefore, it must come up with $86.7 million in the second quarter.
In the third quarter, the firm generates a $120 million cash-flow surplus from operations. Part of that surplus, $86.7 million, is used to pay off the stretched
payables from the second quarter, as it is required to do. A small portion is used to pay interest on its outstanding loans. It uses the remaining cash-flow
surplus, $25.9 million (last line of Panel A), to pay down its bank loan. In the fourth quarter, the firm has a surplus from operations of $170.3 million. It
pays off the interest and remaining principal on the bank loan and is able to invest $93.9 million in cash and marketable securities.
TABLE 30.6 Dynamic Mattress’s financial plan for 2022 (figures in $ millions).
First Quarter Second Quarter Third Quarter Fourth Quarter
A. Cash requirements
Cash required for operationsa 135.6 72.6 –120.0 –170.3
Interest on bank loanb 0 2.5 2.5 1.9
Cost of stretched payablesc 0 0.5 4.3 0
