hard · Principles of Finance financial-statements-markets-wc

In a frictionless market with no taxes, a firm announces it will permanently shorten its cash conversion cycle by negotiating longer payables terms, freeing $50 million of cash that it will hold in marketable securities yielding the risk-free rate. A strong candidate claims this raises firm value by accelerating cash flow. The correct conclusion is that:

1. Firm value is unchanged, because the freed cash is reinvested at a fair (zero-NPV) rate, so the timing benefit is exactly offset and only positive-NPV uses of the cash would add value
2. Firm value rises by the present value of the $50 million accelerated one period, since pulling cash forward always increases value through the time value of money
3. Firm value rises because longer payables represent a free, interest-free loan from suppliers that permanently lowers the firm's weighted average cost of capital
4. Firm value falls, because stretching payables increases counterparty risk premiums that suppliers embed in prices, reducing operating margins by more than the cash benefit

Sign up free to see the explanation and track your rank →