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Chapter 3: 6DQ (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鈥檚 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

鈥淭he most appropriate financing pattern would be one in which asset build-up and length of financing terms are perfectly matched.鈥� Discuss the difficulty involved in achieving this financing pattern.

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.

Route Canal Shipping Company has the following schedule for aging of accounts receivable:

e. What additional information does the aging schedule bring to the company that the average collection period may not show?

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鈥檚 production is equal to annual sales (in units) divided by 12.

Of each month鈥檚 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.

b. Prepare a monthly schedule of cash receipts. Sales in the December before the planning year are \)100,000. Work part b using dollars.

Why are Treasury bills a favorite place for financial managers to invest excess cash?
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