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Carmen’s Beauty Salon has estimated monthly financing requirements for the next six months as follows:

January

\(8,500

February

\)2,500

March

\(3,500

April

\)8,500

May

\(9,500

June

\)4,500

Short-term financing will be utilized for the next six months.

January

9%

February

10%

March

13%

April

16%

May

12%

June

12%

Here are the projected annual interest rates:

a. Compute total dollar interest payments for the six months. To convert an annual rate to a monthly rate, divide by 12. Then multiply this value times the monthly balance. To get your answer, add up the monthly interest payments.

b. If long-term financing at 12 percent had been utilized throughout the six months, would the total-dollar interest payments be larger or smaller? Compute the interest owed over the six months and compare your answer to that in part a.

Short Answer

Expert verified

The interest payable in the finance plan described in part a is $375.35 and $370 in part b. The interest payments will be smaller in part b.

Step by step solution

01

Calculation of monthly interest payable for six months

The total monthly interest payable for six months is $375.35.

Month

Rate

On monthly basis

Amount

Actual interest expense

January

9%

0.75%

$8,500

$63.75

February

10%

0.83%

$2,500

$20.75

March

13%

1.08%

$3,500

$37.80

April

16%

1.33%

$8,500

$113.05

May

12%

1%

$9,500

$95.00

June

12%

1%

$4,500

$45.00

$375.35

02

Calculation of monthly interest payable for six months

The total monthly interest payable for six months is $370.

Month

Rate

On monthly basis

Amount

Actual interest expense

January

12%

1%

$8,500

$85

February

12%

1%

$2,500

$25

March

12%

1%

$3,500

$35

April

12%

1%

$8,500

$85

May

12%

1%

$9,500

$95

June

12%

1%

$4,500

$45

$370

Hence, the interest payments will besmaller if a long-term financing rate is used.

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Most popular questions from this chapter

What does LIBOR mean? Is LIBOR normally higher or lower than the U.S. prime interest rate?

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?

City Farm Insurance has collection centers across the country to speed up collections. The company also makes its disbursements from remote disbursement centers so the firm’s checks will take longer to clear the bank. Collection time has been reduced by two days and disbursement time increased by one day because of these policies. Excess funds are being invested in short-term instruments yielding 12 percent per annum.

a. If City Farm has \(5 million per day in collections and \)3 million per day in disbursements, how many dollars has the cash management system freed up?

Lear Inc. has \(840,000 in current assets, \)370,000 of which are considered permanent current assets. In addition, the firm has \(640,000 invested in fixed assets.

a. Lear wishes to finance all fixed assets and half of its permanent current assets with long-term financing costing 8 percent. The balance will be financed with short-term financing, which currently costs 7 percent. Lear’s earnings before interest and taxes are \)240,000. Determine Lear’s earnings after taxes under this financing plan. The tax rate is 30 percent.

b. As an alternative, Lear might wish to finance all fixed assets and permanent current assets plus half of its temporary current assets with long-term financing and the balance with short-term financing. The same interest rates apply as in part a. Earnings before interest and taxes will be $240,000. What will be Lear’s earnings after taxes? The tax rate is 30 percent.

c. What are some of the risks and cost considerations associated with each of these alternative financing strategies?

Neon Light Company of Kansas City ships lamps and lighting appliances throughout the country. Ms. Neon has determined that through the establishment of local collection centers around the country, she can speed up the collection of payments by three days. Furthermore, the cash management department of her bank has indicated to her that she can defer her payments on her accounts by one-half day without affecting suppliers. The bank has a remote disbursement center in Florida.

c. If the total cost of the new system is $400,000, should it be implemented?

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