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

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%

Calculation of conservative financing plan:

The interest expense will be $165,000.

$\begin{array}{rcl} F i n a n c i n g p l a n & = & T o t a l a s s e t s \times A s s e t s t o b e f i n a n c e d \times I n t e r e s t r a t e \\ = & ($ 1, 200, 000 \times 75 % \times 15 %) + ($ 1, 200, 000 \times 25 % \times 10 %) \\ = & $ 135, 000 + $ 30, 000 \\ = & $ 165, 000 \end{array}$

Calculation of aggressive financing plan:

The interest expense will be $153,750.

$\begin{array}{rcl} F i n a n c i n g p l a n & = & T o t a l a s s e t s \times A s s e t s t o b e f i n a n c e d \times I n t e r e s t r a t e \\ = & ($ 1, 200, 000 \times 56.25 % \times 15 %) + ($ 1, 200, 000 \times 43.75 % \times 10 %) \\ = & $ 101, 250 + $ 52, 500 \\ = & $ 153, 750 \end{array}$

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Short Answer

Step by step solution

Information given in the question:

Calculation of conservative financing plan:

Calculation of aggressive financing plan:

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