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Chapter 3: Q8BP (page 157)

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?

Short Answer

Expert verified

The fixed-cost financing plan is a less costly financing option for the company.

Step by step solution

01

Information given in the question

The following information is provided:

Financing required in next three years = $550,000

Cost of financing = 10.60% per annum

The interest rate on short-term financing inthefirst year = 8.75% per annum

The interest rate on short-term financing inthesecond year = 13.25% per annum

The interest rate on short-term financing in the third year = 10.15% per annum

02

Cost of financing at 12% p.a. interest rate

The cost of financing is $174,900.

Costoffinancing=Borrowedfunds×Interestrate×Time=($550,000×$10.60%p.a.×3)=$174,900

03

Cost of financing using short-term financing

The cost of financing is $176,825.

Costoffinancing=Borrowedfunds×Interestrate×Time=($550,000×$8.75%p.a.×1)=($550,000×$13.5%p.a.×1)=($550,000×$10.5%p.a.×1)=$48,125+×$72,875+$55,825=$176,825

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Most popular questions from this chapter

Bombs Away Video Games Corporation has forecasted the following monthly sales:

January

\(100,000

February

\)93,000

March

\(25,000

April

\)25,000

May

\(20,000

June

\)35,000

July

\(45,000

August

\)45,000

September

\(55,000

October

\)85,000

November

\(105,000

December

\)123,000

Total annual sales

\(756,000

Bombs Away Video Games sells the popular Strafe and Capture video game. It sells for \)5 per unit and costs \(2 per unit to produce. A level production policy is followed. Each month’s production is equal to annual sales (in units) divided by 12.

Of each month’s sales, 30 percent are for cash and 70 percent are on account. All accounts receivable are collected in the month after the sale is made.

d. Prepare a monthly cash budget for January through December using the cash receipts schedule from part b and the cash payments schedule from part c. The beginning cash balance is \)5,000, which is also the minimum desired.

In the second year, Fisk Corporation finds that it can reduce ordering costs to \(2 per order but that carrying costs stay the same at \)1.60 per unit. Also, volume remains at 49,000 units per year.

d. What is the total cost of ordering and carrying inventory?

Using the expectations hypothesis theory for the term structure of interest rates, determine the expected return for securities with maturities of two, three, and four years based on the following data. Do an analysis similar to that in Table 6-6.

1-year T bill at the beginning of year 1

6%

1-year T bill at the beginning of year 2

7%

1-year T bill at the beginning of year 3

9%

1-year T bill at the beginning of year 4

11%

Henderson Office Supply is considering a more liberal credit policy to increase sales, but expects that 9 percent of the new accounts will be uncollectible. Collection costs are 6 percent of new sales, production and selling costs are 74 percent, and accounts receivable turnover is four times. Assume income taxes of 20 percent and an increase in sales of $65,000. No other asset build-up will be required to service the new accounts.

a. What is the level of accounts receivable to support this sales expansion?

In the second year, Fisk Corporation finds that it can reduce ordering costs to \(2 per order but that carrying costs stay the same at \)1.60 per unit. Also, volume remains at 49,000 units per year.

c. What will the average inventory be?
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