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Boatler Used Cadillac Co. requires $850,000 in financing over the next two years. The firm can borrow the funds for two years at 12 percent interest per year. Mr. Boatler decides to do forecasting and predicts that if he utilizes short term financing instead, he will pay 7.75 percent interest in the first year and 13.55 percent interest in the second year. Determine the total two-year interest cost under each plan. Which plan is less costly?

Short Answer

Expert verified

The short-term financing plan, $181,050, isaless costly financing option for the company as the other option has the total cost of financing at $204,000.

Step by step solution

01

Information given in the question

The following information is provided:

Financing required in next two years = $850,000

Cost of financing = 12% per annum

The interest rate on short-term financing inthefirst year = 7.75% per annum

The interest rate on short-term financing inthesecond year = 13.55% per annum

02

Cost of financing at 12% p.a. interest rate

The cost of financing is $204,000

Costoffinancing=Borrowedfunds×Interestrate×Time=$850,000×$12%p.a.×2=$204,000

03

Cost of financing using short-term financing

The cost of financing is $181,050.

Costoffinancing=Borrowedfunds×Interestrate×Time=$850,000×$7.75%p.a.×1+$850,000×$13.55%p.a.×1=$65,875+$115,175=$181,050

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Most popular questions from this chapter

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Esquire Products Inc. expects the following monthly sales:

January

\(28,000

February

\)19,000

March

\(12,000

April

\)14,000

May

\(8,000

June

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July

\(22,000

August

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September

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October

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November

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December

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Cash sales are 40 percent in a given month, with the remainder going into accounts receivable. All receivables are collected in the month following the sale. Esquire sells all of its goods for \)2 each and produces them for \(1 each. Esquire uses level production, and average monthly production is equal to annual production divided by 12.

c. Determine a cash payments schedule for January through December. The production costs (\)1 per unit produced) are paid for in the month in which they occur. Other cash payments (besides those for production costs) are $7,400 per month.

Henderson Office Supply is considering a more liberal credit policy to increase sales, but expects that 9 percent of the new accounts will be uncollectible. Collection costs are 6 percent of new sales, production and selling costs are 74 percent, and accounts receivable turnover is four times. Assume income taxes of 20 percent and an increase in sales of $65,000. No other asset build-up will be required to service the new accounts.

b. What would be Henderson’s incremental after-tax return on investment?

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