CFA 2018 Level 1 Corporate Finance

(1)

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CFA Level 1 JuiceNotes 2017

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(2)

Corporate Governance and ESG

LOS a

LOS b

Shareholder

theory Stakeholder theory

Corporate governance

System of internal controls and procedures by which individual companies are managed.

A framework that deﬁnes rights, roles and responsibilities of various groups

Arrangement of checks and balances a company needs to

minimize and manage the conﬂicting interests between insiders and external shareowners.

1

2 Corporate governance theories

Primary focus is the interest of

ﬁrm’s shareholders Focus under this theory is broader Maximization of MV of ﬁrm’s

common equity

CG is concerned with the conﬂict of interest between managers

and owners

It considers conﬂict of interest among several groups such as

shareholders, employees, suppliers, customers and others.

ç Voting rights ç Residual interest

ç Ongoing interest in proﬁtability and growth, both increasing the value of their shares ç Responsibility to protect the interest of shareholders

ç To hire, fire and set the compensation of the firm’s senior managers ç Monitor financial performance and other ongoing activities.

ç Firm’s executives (most-senior managers) serve on BOD along with directors who are

not otherwise employed by the ﬁrm.

ç One-tier - Both executive and non-executive board members serve on a single BOD

ç Two-tier - Non-executive board members serve on a supervisory board that oversees a

management board, made up of company executives.

ç Compensation - salary, bonus and perquisites

ç Executive bonuses are tied to same measure of ﬁrm performance, giving them a

strong interest in ﬁnancial success of the ﬁrm.

ç They have interest in the pay, opportunities for career advancement, training and

working conditions

ç Providers of debt capital ç Do not have voting rights

ç Do not participate in the ﬁrm’s growth beyond their promised interest and principal

payment

ç Ongoing relationship with the ﬁrm ç Typically short-term creditors

ç They have interest in the ﬁrm’s solvency and ongoing ﬁnancial strength

Shareholders

BOD

Senior managers

Employees

Creditors

Suppliers

Primary stakeholders of a

company

(3)

LOS c

LOS d

Principal-agent

Shareholders

and managers

or BOD

Groups of

shareholders

Creditors and

shareholders

Shareholders

and other

stakeholders

ª It arises because an agent is hired to act in the interest of the principal but the agent’s interest may not coincide exactly with those of the principal.

ª Shareholders are principals and board members are their agents

ª Managers and directors are dependent on ﬁrm for employment

ª They may choose lower level of business risk than the shareholders would since their employment is dependant on ﬁrm’s performance.

ª There is an information asymmetry between shareholders and managers because managers have more and better understanding of the functioning of the ﬁrm. This decreases the ability of the shareholders or non-executive directors to monitor and evaluate whether managers are acting in the best interest of the shareholders.

ª A single shareholder or a group of shareholders may hold a majority of the votes and act against the minority shareholders.

ª Some ﬁrms have different classes of shares, some with more voting power than others.

ª In the event of an acquisition, controlling shareholders may be in a position to get better terms for themselves than minority shareholders.

ª The company may raise prices or reduce product quality to increase proﬁts to the detriment of customers.

ª The company may employ strategies that signiﬁcantly reduce taxes they pay to the government.

ª Shareholders may prefer more risk than creditors do because creditors have a limited upside from good result.

Conﬂict of interest

Mechanism to manage stakeholder relationships

Stakeholder management -

Management of company relations with stakeholders

Voting by proxy

Ordinary

resolution Majority voting

Cumulative

Legal recourse of stakeholders when

their rights are violated

Contract that spell out rights and responsibilities of

company and the stakeholders

Company’s CG procedures including its internal systems

Comprises regulations to which companies

are subject.

LOS e

Assigning one’s right to vote to another

Requires majority of votes. Eg. approval of auditors, election of directors

Candidate with most votes for each single board position is elected

Shareholders can cast all their votes to one single board candidate or divide them among others May require a

supermajority vote.

rd

director, member of management or shareholder’s investment advisor

(4)

LOS f

Board

structure

Board responsibilities

One-tier

board

Senior managers employed by the ﬁrm

Excludes executive

directors Made up of executive directors No other relationship

with the company. Also termed as independent

directors

Two-tier

board

Single BOD Two BODs

External directors / Non executive directors Internal directors /

Executive directors

Supervisory board Management board

Led by company’s CEO

Chairman of the board is sometimes the CEO

Lead independent director -Ability to call meetings of independent directors, separate from meetings

of the full board

Staggered board -

Elections for some board positions are held each year

1

2

3

Audit

committee Governancecommittee Nominations committee Compensation committee committeeRisk Investmentcommittee

Board committees

Ÿ Implementation of accounting policies

Ÿ Effectiveness of internal controls Ÿ Recommending

external auditor Ÿ Proposing

remedies based on audits.

Ÿ CG code

Ÿ Implementing code of ethics and policies regarding conﬂict of int. Ÿ Monitoring changes

in laws and regulations

Ÿ Ensuring company is complying with all laws and regulations

Ÿ Proposes qualiﬁed candidates for election to the board

Ÿ Recommends to the board the amounts of compensation to be paid to directors and senior managers.

Ÿ Informs the board about appropriate risk policy and risk tolerance of the organization reports to the board on management proposals for large acquisitions, sale or disposal of company assets or segments ç Selecting senior management, setting their compensation, evaluating their performance

and replacing them as needed.

ç Setting strategic direction.

ç Approving capital structure changes, acquisitions and large investment expenditures.

ç Reviewing company performance and taking necessary corrective steps.

ç Planning for continuity of management and succession of the CEO.

ç Establishing, monitoring and overseeing firm’s internal controls and risk management

system.

ç Ensuring the quality of the firm’s financial reporting and internal audit.

(5)

LOS g

LOS h

LOS i

They pressure companies in which they hold significant number shares for changes Hedge funds have engaged in shareholder activism to increase the MV of firms in which they hold significant stakes

An activist group may make a tender offer for speciﬁc no. of shares to gain enough votes to take over the company

A threat of hostile takeover can act as an incentive to inﬂuence management and board to pursue policies more in alignment with the interests of shareholders

Activist

shareholders

1

2

When governance is weak and managers are not monitored, they may choose lower-than-optimal risk, reducing company value

Poor compliance procedures with respect to regulation and reporting can easily lead to legal and reputational risks

Effective CG can improve operational efﬁciency by ensuring that management and board member incentives align their interests with those of shareholders

Alignment of management interests with those of shareholders leads to better ﬁnancial performance and greater company value

One class of shares may be entitled to several votes per share, while another class of shares is entitled to one vote per share

On average, companies with a dual class share structure have traded at a discount to comparable companies with a single class of shares

Dual class structure

-Elements of CG that analysts

have found to be relevant

-è Ownership and voting structure è Board composition

è Management remuneration è Composition of shareholders è Strength of shareholder rights è Management of long term risks

Factors that affect stakeholder relationships and CG

Risks of poor CG and beneﬁts of effective CG

Factors relevant to the analysis of CG

Legal

environment

Common-law system Civil law system

Judges’ rulings become law in some instances

Interests of creditors and shareholders are considered to be more protected in countries with

this system

Rights of creditors are more clearly deﬁned than

those of shareholders. Therefore not difﬁcult to enforce through the courts

Judges are bound to rule based on enacted laws

2

(6)

LOS j

LOS k

ESG integration/investing -

The use of environmental, social and governance factors in making investment decisions

Also termed as sustainable investing, responsible investing and socially responsible investing

Certain companies and certain sectors are excluded from portfolios. Eg. mining and oil production sector.

No speciﬁc sectors are excluded from portfolios but investors identify best practices across environmental sustainability.

Negative

screening

-Positive

screening

-1

2 Impact

investing

Thematic

investing

Investing in order to promote speciﬁc social or environmental goals.

Refers to investing based on a single goal. Eg. development of clean water resources

Investors seek to make proﬁt while at the same time having a positive impact on the environment

Environmental and social considerations in investment analysis

Usage of ESG in investment analysis

(7)

Capital Budgeting

LOS a

LOS b

Capital budgeting process

Basic principles of capital

budgeting

Categories of capital

budgeting projects

Analyzing project proposals

Create the ﬁrm- wide capital budget

Monitoring decisions and conducting a post-audit

Externalities

Replacement projects to maintain

the business

Expansion Projects

Mandatory Projects Other projects _{such as R&D} Replacement projects for cost

reduction

New product or market development

Positive

Positiveeffect on sales of a ﬁrm’s other product lines.

Negativeeffect on sales of a ﬁrm’s other product lines.

Cannibalization - New project taking sales from an existing product. Eg. Coke Vs Diet coke Eg. Sales of cars will

increase business of auto components in future.

Negative

4 Decisions are based on cash ﬂows, not accounting income.

4 Consider opportunity costs. 4 Timing of cash ﬂows is important. 4 Consider cash ﬂows after tax.

4 Ignore ﬁnancing cost as a cash outﬂow. 4 Ignore sunk cost as it is irrelevant for

decision making

Without detailed analysis

Fairly detailed analysis

Very detailed

analysis Detailed analysis

Conventional

changes only once

Sign on the cash ﬂows changes more than once

0 1 2 3 0 1 2 3

- 1000 500 500 500 - 1000 800 -600 300

}

Problem of no IRR or multiple IRR

(8)

LOS d

NPV Discounted payback Proﬁtability _index

period

PV of inﬂows PV of outﬂows

PI > 1 = Accept PI < 1 = Reject

PI > 1 = +ve NPV PI < 1 = −ve NPV Time taken to

recover initial investment considering TVM

Poor measure of proﬁtability

Good measure of liquidity

DPB > PB

Time taken to recover initial investment

Shorter the better

Poor measure of proﬁtability

Good measure of liquidity

Doesn’t consider TVM & CFs after

Selection of capital projects

Project sequencing

-Unlimited

funds

rationing

Capital

Mutually exclusive

select all projects, if NPV

> 0

Investment in a project today creates opportunity to invest in projects in future select only one

project (with the highest NPV)

´ Unlimited

access to capital

´ Firm can

undertake all proﬁtable projects

´ Constraints on

raising capital

´ Undertake

projects with highest NPV

LOS c

LOS e

The rate at which NPVs are equal is called as Crossover rate

NPV

(9)

LOS f

NPV

IRR

3 Advantages

Disadvantages

Advantages

Disadvantages

ª Direct measure of the expected increase in the value of ﬁrm

ª Theoretically the best method

ª Does not take size of the project into consideration

ª Measures

proﬁtability as a %

ª Provides information on margin of safety that NPV does not

ª Conﬂict of rankings

ª Multiple IRR / No IRR

ª Assumes

reinvestment at IRR

A +ve NPV should cause proportionate increase in company’s stock price

2 Calculation of crossover rate on TI BA II Plus Professional

Relation between NPV and stock price

Project A

Project B

CPT IRR = 20.61 % (Crossover rate)

-700 250

200

450 600

400 300

-300

150

150 100

-400

CF0 CF1 CF2 CF3

Eg. Investment in new project = $300 mln, PV of future CFs = $400 mln No. of shares outstanding = 50 mln, Market price of share = $25

NPV = $400 mln − $300 mln = $100 mln NPV per share = $100 mln/50 mln = $2 Price of share after new project = $25 + $2 = $27

(10)

Cost of Capital

Equity

Preferred

_stock

Debt

Calculation and interpretation of WACC

Impact of taxes on cost of capital

Capital appreciation

Variable dividend

Dividend is a function

of proﬁtability

Last preference in

case of liquidity and

dividend payment

Fixed dividend

Dividend is a function

of proﬁtability

nd

2 preference in case

of liquidity and

dividend payment

Fixed interest

Interest is to be paid

irrespective of

proﬁtability

st

1 preference in case

of liquidity and

interest payment

WACC

Capital

component Amount Component cost(effective) Weight Weighted average

Equity 1000 20% 20% 4%

Preferred stock 2000 15% 40% 6%

Debt 2000 10% 40% 4%

Total 5000 100% 14%

Costs

Equity Preferred Debt

stock

Kce Kps K x (1-t)d

LOS a

LOS b

1

2

Interest paid on corporate debt is tax deductible

No tax deduction is allowed for payments to common or preferred stockholders Marginal cost of capital = Weighted average cost of capital

(11)

LOS c

LOS d

LOS e

LOS f

LOS g

LOS h

The weights in the calculation of WACC should be based on market values not book values

Amount of capital invested Cost of Capital / IRR

Investment Opportunity

Schedule

Marginal Cost of Capital

Optimal Capital Budget

WACC is appropriate discount rate for projects that have approximately the same level of risk as the ﬁrm’s existing projects Project with greater than average risk = Discount rate greater than WACC

Project with below-average risk = Discount rate less than WACC

True cost of debt is its YTM, not the coupon rate.

K = YTM x (1 - t)

d

If YTM is not available because the ﬁrm’s debt is not publicly traded, the analyst can use

matrix pricing to estimate the before-tax cost of debt.

How to determine weights in capital structure

WACC’s role in determining NPV

Cost of debt

Market Risk Premium (MRP)

Retention Ratio × ROE

Ad hoc approach

Analysts add a risk premium to the

market yield on ﬁrm’s long term debt

1 − Payout ratio DPS_EPS

PAT Equity Capital Asset

Pricing Model Model / Dividend Gordon Growth discount model

K =ce D_P1+ g 0

Cost of equity

Bond yield + Risk Premium

K = RFR + (R - RFR) x βce m

FinTree

K =

ps

Preference Dividend

_{Price of stock}

(12)

LOS i

LOS j

Beta - measure of

systematic risk

/market risk

Y = a + bx

Dependant variable

Independent variable

Challenging issues with beta

Use of country risk premium in estimating cost of equity

Intercept Slope/beta

Beta =

Covariance (_{Variance (}_ms,m₎ )

Pure-play method

1

2

3

Country Risk Premium

-Sovereign yield spread

-It is added to MRP (in CAPM) to reﬂect increased risk associated with investing in a developing country

Yield of developing country’s govt. bond (denominated in developed country’s currency) − Yield on Treasury bond of similar maturity

Developing country

Developed country SD of market

SD of debt X

CRP =

Eg.

Sovereign yield spread

Ê Beta is estimated using historical returns data. The estimate is sensitive to the length

of time used and frequency.

Ê Betas exhibit mean reversion tendency (aka beta drift).

Ê Beta of the entire market is 1, therefore all betas have a tendency to move toward 1 and

estimate may need to be adjusted.

Ê The estimate is affected by index chosen.

Ê Beta may need to be adjusted upward for small ﬁrms to reﬂect inherent risk in them.

K = RFR + (MRP + CRP) x βce

K = 4 + [(9 − 4) + 5) x 1.5ce

K = 19%ce

Beta of a comparable

company

Asset beta

(Equity beta)

Project beta

(Unlever)

(Relever)

Divide

D/E of comparable

company

D/E of our company

Multiply

1 + D/E ratio (1 − t)

RFR = 4% R = 9%m

CRP = 5% Beta = 1.5

(13)

LOS k

LOS l

Different sources of ﬁnancing become more expensive as the ﬁrm raises more capital The Marginal cost of capital schedule shows

WACC for different amounts of ﬁnancing The MCC schedule is shown as graph and

typically has an upward slope The break points occur when the cost of

one the components of WACC changes

Break point =

Amt. of capital at which cost changes_{Weight of the component}

WACC

Capital raised

The correct method to account for ﬂoatation costs is to calculate the dollar amount of cost and increase the initial cash outﬂow by this amount.

It should not be incorporated directly into the cost of equity because it is not an ongoing expense and it would lead to increase in WACC which in turn will reduce the NPV

Marginal cost of capital schedule

Treatment of ﬂoatation cost

(14)

LOS b

Measures of Leverage

Leverage refers to the amount of

ﬁxed costs

a ﬁrm has.

Operating ﬁxed cost (OFC)

∆ operating earnings > ∆ sales

∆ net income > ∆ operating

earnings Degree of

Operating Leverage

Degree of Financial Leverage Financing ﬁxed

cost (FFC)

1

3

2 Business risk

Financial risk

Risks

Sales risk

Uncertainty about ﬁrm’s sales

Additional risk borne by shareholders because of debt

ﬁnancing

Additional uncertainty about operating

earning

Operating risk

Degree of operating

leverage (DOL) Degree of ﬁnancial leverage (DFL) Degree of combined leverage (DCL)

% ∆ EBIT % ∆ sales

Sales − VC EBIT

Highest at low level of sales

If there’s no OFC, DOL=1

DOL × DFL

% ∆ EPS % ∆ sales

Sales − VC EBT % ∆ EPS

% ∆ EBIT

EBIT EBT

If there’s no FFC, DFL=1

LOS a

Variable

cost

Fixed

cost

Fixed

cost Variable cost

Low leverage

High leverage

(15)

LOS d

LOS e

ﬁrm must generate to cover its FC & VC

to generate

desired proﬁt

=

OFC + Interest Contribution per unit

OFC + Interest + Des. proﬁt Contribution per unit

Operating ﬁxed cost Contribution per unit

LOS c

Use of ﬁnancial leverage increases the risk of default but also increases the potential return for equity shareholders

Net income

Effect of ﬁnancial leverage on ROE

2 1000

Breakeven point (in amount) = _{Contribution ratio}Fixed cost

Contribution ratio = Contribution_Sales

(16)

Eg. Operating fixed cost = 10,000 Financing fixed cost = 20,000 Selling price = 100 Variable cost = 60 Desired profit = 30,000

Contribution per unit = = =

Selling price − Variable cost 100 − 60

40

Operating breakeven =

=

OFC

Contribution per unit 10,000

40 250 Contribution ratio =

=

Contribution per unit Sales per unit 40

100 40%

Total breakeven =

Breakeven (in amount) = =

= =

=

OFC + FFC Contribution per unit

OFC + FFC Contribution ratio 10,000 + 20,000

40

10,000 + 20,000 40% 750

75,000

(17)

Dividends and Share Repurchases

schedule eg.

quarterly

Proceeds of liquidation

è In theory value of a stock reduces by the

amount of dividend on ex-dividend date.

è The payment of cash dividend reduces a

company’s Assets and MV of its Equity.

Stock

dividends Stock splits stock splitsReverse

Dividends in shares/stocks

Retained earnings decrease

Equity share capital increases

Total equity remains

unchanged

Combination of multiple shares

into one

Shareholder’s wealth is

unchanged

A company whose stock has fallen dramatically may

declare Reverse stock split Division of

each share into multiple shares

No. of shares increase Price of shares

decrease

Value of shareholder’s total shares is

unchanged

Stock dividends, stock splits and reverse stock splits have no effect on company’s leverage ratios or liquidity ratios

1

3

2

Declaration

date Cum-dividend date Ex-dividend date _{record date}Holder of Payment _date

Feb. 24 Mar. 13 Mar. 14 Mar. 16 Mar. 31

If a person buys shares on or after ex-dividend date, he will not receive the dividend Settlement cycle in US = T + 3

Dividend payment chronology

Types of dividends and their effect on

shareholders’ wealth and company’s ratios

Cash dividend decreases asset (cash) and shareholders’ equity (retained earnings)

Other things equal, decrease in cash decreases liquidity ratios and increases debt-to-assets ratio

Decrease in retained earnings, increases debt-to-equity ratio

(18)

LOS d

LOS e

EPS

MPS

Proﬁt after tax

No. of shares outstanding

BV of Assets − BV of Liabilities

No. of shares outstanding

YTM × (1 − t)

Earning yield =

EPS =

BVPS =

Cost of borrowing =

If earning yield > borrowing cost

-Impact of share repurchase on EPS

Impact of share repurchase on BVPS

If BVPS (old) > MPS

If MPS > BVPS (old)

-If borrowing cost > earning yield -

EPS

BVPS (new)

LOS c

Share repurchase methods

Open market

Tender offer

Direct negotiation

Prevailing market price

Gives company the ﬂexibility to choose the timing of the transaction

Premium to market price

Shareholders may tender their shares according to

the terms of the offer

Premium to market price

Direct negotiation with a large shareholder to buyback a block of shares

Eg. (LOS d)

EPS will increase after buyback, because earning yield > after tax cost of debt

Share price before buyback = $40 Shares outstanding before buyback = 120,000 EPS before buyback = $3 Cost of debt = 9% Tax rate = 30% Planned buyback = 20,000

After tax cost of debt = = =

9 × (1 − t) 9 × (1 − 0.3) 6.3%

Earning yield = = =

EPS/MPS 3/40 7.5%

EPS after buyback =

=

Net income − After tax cost of funds Shares outstanding after buyback (3 × 120,000) − (20,000 × 40 × 6.3%)

(120,000 − 20,000) 360,000 − 50,400

100,000

$3.096

(19)

LOS f

5 shares x 100 = 500

20 per share

1 share

Why cash dividend and share repurchase of same amount are

equivalent in terms of effect on shareholders’ wealth

Value of shares

400 (80 x 5)

Value of shares

500 Value of shares₄₀₀

Cash

100 (20 x 5)

Cash

0 Cash100

A share repurchase can be considered as an alternative to cash dividend Assuming the tax treatment is same, share repurchase and cash dividend

have same impact on shareholder’s wealth

Original scenario

Cash dividend

Share repuechase

Wealth

Eg. (LOS e)

Share price before buyback = $40 Shares outstanding before buyback = 120,000 Book value = $2.4 mln Planned buyback = $800,000

Current BVPS =

=

2,400,000 120,000 20

No. of shares in buyback =

=

$800,000 $40

20,000

=

2,400,000 − 800,000 120,000 − 20,000

16

New BVPS = Opening BV − Planned buyback Shares outstanding after buyback

New BVPS will decrease, because Current BVPS < MPS

(20)

Working Capital Management

What is Working Capital ?

Sources of liquidity

1

2

1

2

Capital (1000)

P

ull on utﬂows

O

D

rag on nﬂows

I

Factory (700)

Cash (300)

Inventory Accounts

Receivable

Working Capital = Current Assets - Current Liabilities

Current liabilities Amt. Current assets Amt.

Accounts Payable 100 Inventory 100+100

Accounts Receivable 100

Cash 100

Total 100 Total 400

Used in normal day to day operations

è Selling good

è Collecting from AR

è Short-term funding

è Trade credit

è Line of credit

Used in deteriorating ﬁnancial conditions

è Selling assets

è Negotiating debts

(restructuring)

Factors that inﬂuence a

company’s liquidity position

LOS a

D I

P O

Eg. Uncollected receivables, obsolete inventory

Eg. Paying vendors sooner than is optimal

Primary

sources

Secondary

sources

Working capital is still 300 100 worth of current assets are funded by

Current Liabilities

Working Capital

(21)

LOS b

LOS c

LOS d

LOS e

Liquidity

Ratios

Activity

Ratios

4 Current ratio = CA / CL

4 Quick ratio (acid test ratio) = CA − Inventory/CL

4 Cash ratio = Cash + Marketable Sec. / CL

4 ARTR = Credit Sales / Avg Accounts Receivable

4 ITR = COGS / Avg Inventory

4 WCTR = Sales / Working Capital

4 APTR = Purchases / Avg Accounts Payable

Daily cash position refers to uninvested cash balances a ﬁrm has available to make routine

purchases and pay expenses as they come due.

Purpose of managing daily cash position - To have sufﬁcient cash on hand (make sure net daily cash position never becomes negative) but to avoid keeping excess cash because of interest income forgone by not investing

Higher

the better

Lower

the better

30

AR

Inventory

₄₀

Cash

50

Accounts payable

-30

50

0

70

Operating cycle (70) =No. of days in Inventory (30) + No. of days in AR (40)

Cash Cycle (20) = Operating cycle (70) −No. of days in AP (50)

Holding period yield

Effective earning yield

Money market yield

Bank discount yield

Bond equivalent yield

970 1000

3 mistakes analogy to

remember the formulas

(indicated in red)

j No Compounding

k 365 days

l Investment value

as base

k 360 days

l Investment value as base

j Compounding k 365 days l Investment

value as base

k 360 days

(22)

LOS f

LOS g

Cost of Trade Credit

Choices of short term funding

0

20

90 3/20 Net 90

Uncommitted

Committed

_(regular)

Revolving

97

100

PV = −97 FV = 100 N = 70/365 I/Y = 17.21%

70

Bank may refuse to lend if circumstances change.

Least reliable Reliable Most reliable Typically for longer terms. Bank charges a fee for

making the commitment.

7 %

2 _{Add on yield}

Discount yield

100 (investment

value)

93 (investment

value) 107

(face value)

100 (face value)

Interest

Investment value Face valueInterest

3 IPS should have:

g Guidelines about the

strategy

g Types of securities

allowed

g Persons responsible

for complying with the guidelines

g Limitations on credit

rating of portfolio securities

Every ﬁrm should

have a written IPS

Most preferred yield for Money market instrument

Bond equivalent yield

If inventory levels are too low, it will result in loss of sales due to stock-outs.

If credit terms are strict, it will lead to lower sales.

If credit terms are lenient, it will lead to increase in sales but at the cost of longer average days of receivables. It may also increase bad debts.

If inventory levels are too high, it will result in more carrying costs.

Cost of borrowing < Cost of annual trade credit = Take the discount