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Guardian Inc. is trying to develop an asset financing plan. The firm has \(400,000 in temporary current assets and \)300,000 in permanent current assets. Guardian also has $500,000 in fixed assets. Assume a tax rate of 40 percent.

a. Construct two alternative financing plans for Guardian. One of the plans should be conservative, with 75 percent of assets financed by long-term sources, and the other should be aggressive, with only 56.25 percent of assets financed by long-term sources. The current interest rate is 15 percent on long-term funds and 10 percent on short-term financing.

Short Answer

Expert verified

The interest expense in the conservative approach will be $165,000 and $153,750 in the aggressive approach.

Step by step solution

01

Information given in the question:

The following information is provided:

Temporary current assets =$400,000

Permanent current assets =$300,000

Fixed assets =$500,000

Total assets =$1,200,000

Tax rate = 40%

02

Calculation of conservative financing plan:

The interest expense will be $165,000.

Financingplan=Totalassets×Assetstobefinanced×Interestrate=($1,200,000×75%×15%)+($1,200,000×25%×10%)=$135,000+$30,000=$165,000

03

Calculation of aggressive financing plan:

The interest expense will be $153,750.

Financingplan=Totalassets×Assetstobefinanced×Interestrate=($1,200,000×56.25%×15%)+($1,200,000×43.75%×10%)=$101,250+$52,500=$153,750

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Most popular questions from this chapter

Bombs Away Video Games Corporation has forecasted the following monthly sales:

January

\(100,000

February

\)93,000

March

\(25,000

April

\)25,000

May

\(20,000

June

\)35,000

July

\(45,000

August

\)45,000

September

\(55,000

October

\)85,000

November

\(105,000

December

\)123,000

Total annual sales

\(756,000

Bombs Away Video Games sells the popular Strafe and Capture video games. It sells for \)5 per unit and costs $2 per unit to produce. A level production policy is followed. Each month’s production is equal to annual sales (in units) divided by 12.

Of each month’s sales, 30 percent are for cash and 70 percent are on account. All accounts receivable are collected in the month after the sale is made.

a. Construct a monthly production and inventory schedule in units. Beginning inventory in January is 25,000 units. (Note: To do part a, you should work in terms of units of production and units of sales.)

Biochemical Corp. requires $550,000 in financing over the next three years. The firm can borrow the funds for three years at 10.60 percent interest per year. The CEO decides to do a forecast and predicts that if she utilizes short-term financing instead, she will pay 8.75 percent interest in the first year, 13.25 percent interest in the second year, and 10.15 percent interest in the third year. Determine the total interest cost under each plan. Which plan is less costly?

In Problem 18, what long-term interest rate would represent a break-even point between using short-term financing as described in part a and long-term financing? (Hint: Divide the interest payments in 18a by the amount of total funds provided for the six months and multiply by 12.)

Sauer Food Company has decided to buy a new computer system with an expected life of three years. The cost is \(150,000. The company can borrow \)150,000 for three years at 10 percent annual interest or for one year at 8 percent annual interest.

How much would Sauer Food Company save in interest over the three-year life of the computer system if the one-year loan is utilized and the loan is rolled over (reborrowed) each year at the same 8 percent rate? Compare this to the 10 percent three-year loan. What if interest rates on the 8 percent loan go up to 13 percent in year 2 and 18 percent in year 3? What would be the total interest cost compared to the 10 percent, three-year loan?

Using the expectations hypothesis theory for the term structure of interest rates, determine the expected return for securities with maturities of two, three, and four years based on the following data. Do an analysis similar to that in the right-hand portion of Table 6-6.

1-year T bill at the beginning of year 1

5%

1-year T bill at the beginning of year 2

8%

1-year T bill at the beginning of year 3

7%

1-year T bill at the beginning of year 4

10%

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