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Chapter 3: Q6DQ (page 182)

By using long-term financing to finance part of temporary current assets, a firm may have less risk but lower returns than a firm with a normal financing plan. Explain the significance of this statement.

Short Answer

Expert verified

Long-term financing is an expensive financing method, whichwill lower the organization’s profits.

Step by step solution

01

Meaning of long-term financing

Long-term financing refers to the financing taken by an organization for more than one year. This financing option is taken to fulfil the long-term financial requirements of the organization.

02

The significance of the given statement

If the company uses long-term financing for its current temporary assets, it will provide the necessary funds in the long term, but the cost of long-term financing is higher than that of short-term financing. So, the profits generated by the organization will be lower when utilizing long-term financing.

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Most popular questions from this chapter

In the management of cash and marketable securities, why should the primary concern be for safety and liquidity rather than maximization of profit?

Assume that Hogan Surgical Instruments Co. has \(2,500,000 in assets. If it goes with a low-liquidity plan for the assets, it can earn a return of 18 percent, but with a high-liquidity plan, the return will be 14 percent. If the firm goes with a short-term financing plan, the financing costs on the \)2,500,000 will be 10 percent, and with a long-term financing plan, the financing costs on the $2,500,000 will be 12 percent. (Review Table 6-11 for parts a, b, and c of this problem.)

a. Compute the anticipated return after financing costs with the most aggressive asset financing mix.

b. Compute the anticipated return after financing costs with the most conservative asset financing mix.

c. Compute the anticipated return after financing costs with the two moderate approaches to the asset financing mix.

d. Would you necessarily accept the plan with the highest return after financing costs? Briefly explain.

Assume that Atlas Sporting Goods Inc. has \(840,000 in assets. If it goes with a low-liquidity plan for the assets, it can earn a return of 15 percent, but with a high-liquidity plan the return will be 12 percent. If the firm goes with a short-term financing plan, the financing costs on the \)840,000 will be 9 percent, and with a long-term financing plan, the financing costs on the $840,000 will be 11 percent. (Review Table 6-11 for parts a, b, and c of this problem.)

a. Compute the anticipated return after financing costs with the most aggressive asset financing mix.

b. Compute the anticipated return after financing costs with the most conservative asset financing mix.

c. Compute the anticipated return after financing costs with the two moderate approaches to the asset financing mix.

d. If the firm used the most aggressive asset financing mix described in part a and had the anticipated return you computed for part a, what would earnings per share be if the tax rate on the anticipated return was 30 percent and there were 20,000 shares outstanding?

e. Now assume the most conservative asset financing mix described in part b will be utilized. The tax rate will be 30 percent. Also assume there will only be 5,000 shares outstanding. What will earnings per share be? Would it be higher or lower than the earnings per share computed for the most aggressive plan computed in part d?

Fisk Corporation is trying to improve its inventory control system and has installed an online computer at its retail stores. Fisk anticipates sales of 49,000 units per year, an ordering cost of \(8 per order, and carrying costs of \)1.60 per unit.

c. What will the average inventory be?

Oral Roberts Dental Supplies has annual sales of \(5,200,000. Ninety percent are on credit. The firm has \)559,000 in accounts receivable. Compute the value of the average collection period.
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