Additional Financial Management Problems
A. Robin Supplies Company expects sales next year to be $500,000. Inventory and accounts
receivable will increase $90,000 to accommodate this sales level. The company has a
steady profit margin of 12 percent with a 40 percent dividend payout. How much external
financing will Tobin Supplies Company have to seek? Assume there is no increase in
liabilities other than that which will occur with the external financing.
B. Electric Chair and Table Co. expects sales next year to be $10,000,000. Inventory and
accounts receivable will increase by $1,400,000 and accounts payable will increase by
$300,000. The company has a profit margin of 9 percent and pays out 30 percent of profits
in dividends. How much external financing will be necessary?
Assume there is no increase in liabilities other than that which will occur with the
external financing
C. Procter Micro-Computers, Inc., requires $1,200,000 in financing over the next two years.
The firm can borrow the funds for two years at 9.5 percent interest per year. Mr. Procter
decides to do economic forecasting and determines that if he utilizes short-term financing
instead, he will pay 6.55 percent interest in the first year and 10.95 percent interest in the
second year. Determine the total two-year interest cost under each plan. Which plan is
less costly?
D. Sauer Food Company has decided to buy a new computer system with an expected life of
three years. The cost is $150,000. The company can borrow $150,000 for three years at
10 percent annual interest or for one year at 8 percent annual interest.
How much would Sauer Food Company save in interest over the three-year life of the
computer system if the one-year loan is utilized and the loan is rolled over (reborrowed)
each year at the same 8 percent rate? Compare this to the 10 percent three-year loan. What
if interest rates on the 8 percent loan go up to 13 percent in year 2 and 18 percent in year 3?
What would be the total interest cost compared to the 10 percent, three-year loan?
E. 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.
b. Given that Guardian’s earnings before interest and taxes are $200,000, calculate
earnings after taxes for each of your alternatives.
c. What would happen if the short-and long-term rates were reversed?
F. Lear, Inc., has $800,000 in current assets, $350,000 of which are considered permanent
current assets. In addition, the firm has $600,000 invested in fixed assets.
a. Lear wishes to finance all fixed assets and half of its permanent current assets with
long-term financing costing 10 percent. Short-term financing currently costs 5 percent.
Lear’s earnings before interest and taxes are $200,000. Determine Lear’s earnings after
taxes under this financing plan. The tax rate is 30 percent.
b. As an alternative, Lear might wish to finance all fixed assets and permanent current
assets plus half of its temporary current assets with long-term financing. The same
interest rates apply as in part a. Earnings before interest and taxes will be $200,000.
What will be Lear’s earnings after taxes? The tax rate is 30 percent.
c. What are some of the risks and cost considerations associated with each of these
alternative financing strategies?
G. Slipshod Machine Tool Co. owes $40,000 to one of its suppliers. The supplier has offered a
trade discount of 2/10 net 30. Slipshod can borrow the funds from either of two banks: First City
Bank will loan the funds for 20 days at a cost of $400; Upstart Bank offers a discounted loan for
20 days at a cost of $320.
a) What is the cost of failing to take the discount?
b) What is the effective interest rate on each of the loans?
c) Should Slipshod take the cash discount?
d) Which bank loan should Slipshod use?
H. Brand Advertising is offered a 3/10 net 40 trade discount by its supplier. In the past Brand
has been able to get away with paying for supplies on credit in 60 days. Since it doesn't have
money on hand to take advantage of the discount, it tries to negotiate a loan with Portland State
Bank. The amount of $375,000 with a 15% compensating balance and a $5,500 interest charge
has been negotiated for the month of May. Brand already maintains a $16,250 balance at the
bank. Compute the effective rate of interest on the loan, and the cost of not taking the discount.
Should Brand take advantage of the cash discount?
I . Business Book Publishing needs to borrow $700,000 in order to finance its new inventory.
Two banks they were considering offered different annual loan terms: Marine Bank offered a
10% loan with a 15% compensating balance to be paid back in quarterly payments. McLean
National Bank offered Business Book Publishing a 12% loan to be paid back semi-annually.
Which loan terms should Business Book Publishing take?
J. In order to finance a shipment of badminton sets, Rujisawa Import-Export is seeking a
$500,000 one-year bank loan. The Marine Bank requires that Rujisawa maintain a 20%
compensating balance and requires four quarterly payments. The Lincoln Bank requires only a
10% compensating balance, but requires 12 monthly payments. In addition, Lincoln discounts
the loan. Both banks state that their interest rate is 9%.
a) Which bank has the lowest effective interest rate?
(NOTE: deduct the compensating balances from the principal in determining the effective rate)
b) If Lincoln Bank eliminated its compensating-balance requirement, would your answer
change?