Questions on multiple IRRs and sales receivables multiple, decrease, increase, interest, current

whew1110

Hey guys,

I have two questions I need some help on plz

1) How do you tell when a project has multiple IRR or no IRR at all?

For example
t 0 1 2
Project A 100 -275 300
Project B -100 300 -200

>> According to the answers Prjoect A has multiple IRRs and Project has no IRR

explain plzzz



2) A Sale of receivables can lead to :

a)an increase in the interest coverage ratio and a decrease in D/E ratio
b) an increase in the interest coverage ratio and a decrease in the current ratio
c) a decrease in the interest coverage ratio and an increase in D/E ratio

>>> answer is A

I chose B because I thought sale of receivables usually occurs at a discount so therefore you get less cash for the A/R so I assumed CA would fall therefore decreasing current ratio. I am a bit confused about why the answer is A since I would assume that a fall in A/R could decrease equity and raise D/E ratio?

anyone explain plz

jim8z3

> t 0 1 2
> Project A 100 -275 300
> Project B -100 300 -200
>
> >> According to the answers Prjoect A has multiple
> IRRs and Project has no IRR
>
Whenever you try solve for IRR and get a second degree equation with IRR as unknown, you can get 2 IRR instead of 1 IRR. It is the case of project A. As a rule, when you have a future cash flow a mix bag of in and out flow, whereas if you have a clean, plain vanilla case with one outflow at start then only inflow in future, you have only IRR.

Project BB has IRR =0, i.e., rate of return =0, it is easy to see since you have sum of all (undiscounted) cash flow =0 --> you don't earn any return at all.


> 2) A Sale of receivables can lead to :
>
> a)an increase in the interest coverage ratio and a
> decrease in D/E ratio
> b) an increase in the interest coverage ratio and
> a decrease in the current ratio
> c) a decrease in the interest coverage ratio and
> an increase in D/E ratio
>
> >>> answer is A

Hmm
I would vote for C, assuming that we are talking about plain vanilla sales of receivables with cash upfront (i.e., non recourse factoring, not fancy securitization or even factoring with recourse)
since the transaction will increase the interest expense with (face value of receivables - cash received) --> interest coverage = EBIT/interest would decrease since EBIT stays the same.

Increase D/E since debt stays the same and equity lower because of increased interest expense as you mention earlier.

current ratio would decrease, as you mentioned earlier.

dontknow1987

elcfa... I like the explanation and agree with it..

Now, could you also confirm if the same would occur in case of "borrowing on recvbles" were to occur?
imo "YES"

What would the analyst adjustments be in this case? OR is it that the sale of recievables be treated as "borrowing on recvbles" and adjust the int. coverage and D/E?

Matori

> 2) A Sale of receivables can lead to :
>
> a)an increase in the interest coverage ratio and a
> decrease in D/E ratio
> b) an increase in the interest coverage ratio and
> a decrease in the current ratio
> c) a decrease in the interest coverage ratio and
> an increase in D/E ratio
>
> >>> answer is A

Answer A is correct.

Interest Coverage Ratio = EBIT / Interest Expense

Now, with Sales of Receivables, EBIT is not going to change. Because, your Revenues, COGS, Operating expenses are all going to be unchanged. Whereas your Interest Expense would reduce. The cash you got could go in repaying some short term debts and thus reducing your Interest Expense.

Regarding discount on Sale of Receivables reducing CA, it is not true. $100, 3 months from now is worth $90 today anyways (discounted by firm's avg debt rate).

However, your arguments do make sense, but we have to look for the best alternative among given choices.

farrukhsadiq

ov25

If we are talking about collateralized loan, then the receivables are not removed from the book, but record the loan transaction like if you issue a short-term balloon payment bond/loan.
DR cash 95
DR prepaid interest 5
CR Loan payable 100

If the loan is repaid before balance date --> same case as above.
If not, the loan still stays on the book (assuming further that the company does calculate the accrued interest, most don't in reality for short period)

In this case, EBIT stays same, interest increases so interest coverage decreases.

Debt increases and Equity decreases --> D/E increases.

Increased D/E since debt increases and equity lower because of increased interest expense as you mentioned earlier.

current ratio would be hard to predict, since both current asset and current liabilities increases.

rus1bus
>The cash you got could go in repaying some short term debts and thus reducing your
> Interest Expense.

Two things:
- Not sure you can make that assumption (which may or may not be true).
- Even if true, it still may not change the conclusion since say you get 100 from sales (which has implicit financing rate of 6%) and you use it to pay down your short term debt with 4% rate --> your net interest expense still increases.

>Regarding discount on Sale of Receivables reducing CA, it is not true.
> $100, 3 months from now is worth $90 today anyways (discounted by firm's avg debt rate)

Well, it is common practice that the buyer of your receivables to pay you a lower amount for what he expects to get in the future (if he thinks he will have any non-collections, the rate will be higher, as well as their admin cost) and the discount rate can be quite high, so firm avg. debt rate may not be relevant here, in my opinion.