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Chapter 3: Q14BP_a (page 187)

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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