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Chapter 3: Q7DQ (page 182)

A firm that uses short-term financing methods for a portion of permanent current assets is assuming more risk but expects higher returns than a firm with a normal financing plan. Explain.

Short Answer

Expert verified

Short-term financing is available at lower interest rates than that of long-term financing, resultingin higher profits for the organization.

Step by step solution

01

Meaning of short-term financing

Short-term financing is the process of using different sources of finance for obtaining finance for less than one year. This method is usually used to meet the working capital requirements of the organization.

02

The explanation of the given statement

Short-term financing is offered at lower interest rates than the sources of long-term financing. If this method is used for permanent assets, it would be risky as the finance may not available at all times, but the cost of this method of financing will be low, resulting in higher profits for the organization.

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Most popular questions from this chapter

What is the difference between pledging accounts receivable and factoring accounts receivable?

Colter Steel has \(4,200,000 in assets.

Temporary current assets

\)1,000,000

Permanent current assets

\(2,000,000

Fixed assets

\)1,200,000

Total assets

\(4,200,000

Short-term rates are 8 percent. Long-term rates are 13 percent. Earnings before interest and taxes are \)996,000. The tax rate is 40 percent. If long-term financing is perfectly matched (synchronized) with long-term asset needs, and the same is true of short-term financing, what will earnings after taxes be? For a graphical example of perfectly matched plans, see Figure 6-5.

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.

c. What would happen if the short- and long-term rates were reversed?

Johnson Electronics is considering extending trade credit to some customers previously considered poor risks. Sales would increase by \(150,000 if credit is extended to these new customers. Of the new accounts receivable generated, 5 percent will prove to be uncollectible. Additional collection costs will be 2 percent of sales, and production and selling costs will be 74 percent of sales. The firm is in the 35 percent tax bracket.

Assume that Henderson also needs to increase its level of inventory to support new sales and that inventory turnover is two times.

d. What would be the total incremental investment in accounts receivable and inventory to support a \)65,000 increase in sales?

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.

b. How many orders will be placed during the year?
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