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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

Eastern Auto Parts Inc. has 15 percent of its sales paid for in cash and 85 percent on credit. All credit accounts are collected in the following month. Assume the following sales:

January

\(65,000

February

\)55,000

March

\(100,000

April

\)45,000

Sales in December of the prior year were $75,000. Prepare a cash receipts schedule for January through April.

Fast Turnstiles Co. is evaluating the extension of credit to a new group of customers. Although these customers will provide \(180,000 in additional credit sales, 12 percent are likely to be uncollectible. The company will also incur \)16,200 in additional collection expense. Production and marketing costs represent 72 percent of sales. The firm is in a 34 percent tax bracket and has a receivables turnover of four times. No other asset build-up will be required to service the new customers. The firm has a 10 percent desired return.

a. Calculate the incremental income after taxes and the return on incremental investment. Should Fast Turnstiles Co. extend credit to these customers?

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%

Thompson Wood Products has credit sales of \(2,160,000 and accounts receivable of \)288,000. Compute the value of the average collection period.

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.
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