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Strategic Corporate Finance: Applications in Valuation and Capital Structure by Justin Pettit

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MAINTAIN FINANCIAL LIQUIDITY TO “INSURE” YOUR EQUITY

We have seen analysts and agencies placing a greater emphasis on carrying a stronger cash and liquidity position, yet low interest rates have led to some large short-term floating-rate debt portfolios. A combination of the following actions enhance liquidity:

  • Improve base case quarterly cash flows, or identify discretionary sources of liquidity (such as deferrable costs, capex, dividends, and working capital).
  • Hold more operating cash and marketable securities.
  • Maintain near-cash equivalents such as undrawn lines (beyond what is required to backstop a commercial paper program).
  • Reduce commercial paper exposure.

Essentially, two types of cash draws exist: expected and unexpected. Events whose timing and amount are determined are a draw on operating cash flow and external financing. For example, repayment of a previously incurred liability or contractually obligated payments such as underfunded pensions and postdirect benefits. Events that are uncertain with respect to amount, timing, or occurrence are a draw on liquidity. Financial and operating leverage magnify their impact, but liquidity should be sufficient to absorb these events, such as volatility of interest rates, prices, costs or volumes, environmental liabilities, litigation.

Cost of Financial Liquidity

The costs of holding too much cash are more apparent in this low interest rate environment than ever, with a low rate of return earned, double taxation of interest income, ...

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