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Chapter 3: 7BP (page 185)

Boatler Used Cadillac Co. requires $850,000 in financing over the next two years. The firm can borrow the funds for two years at 12 percent interest per year. Mr. Boatler decides to do forecasting and predicts that if he utilizes short term financing instead, he will pay 7.75 percent interest in the first year and 13.55 percent interest in the second year. Determine the total two-year interest cost under each plan. Which plan is less costly?

Short Answer

Expert verified

The short-term financing plan, $181,050, isaless costly financing option for the company as the other option has the total cost of financing at $204,000.

Step by step solution

01

Information given in the question

The following information is provided:

Financing required in next two years = $850,000

Cost of financing = 12% per annum

The interest rate on short-term financing inthefirst year = 7.75% per annum

The interest rate on short-term financing inthesecond year = 13.55% per annum

02

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

The cost of financing is $204,000

Costoffinancing=Borrowedfunds脳Interestrate脳Time=$850,000脳$12%p.a.脳2=$204,000

03

Cost of financing using short-term financing

The cost of financing is $181,050.

Costoffinancing=Borrowedfunds脳Interestrate脳Time=$850,000脳$7.75%p.a.脳1+$850,000脳$13.55%p.a.脳1=$65,875+$115,175=$181,050

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Most popular questions from this chapter

Discuss the relative volatility of short- and long-term interest rates

City Farm Insurance has collection centers across the country to speed up collections. The company also makes its disbursements from remote disbursement centers so the firm鈥檚 checks will take longer to clear the bank. Collection time has been reduced by two days and disbursement time increased by one day because of these policies. Excess funds are being invested in short-term instruments yielding 12 percent per annum.

b. How much can City Farm earn in dollars per year on short-term investments made possible by the freed-up cash?

Lear Inc. has \(840,000 in current assets, \)370,000 of which are considered permanent current assets. In addition, the firm has \(640,000 invested in fixed assets.

a. Lear wishes to finance all fixed assets and half of its permanent current assets with long-term financing costing 8 percent. The balance will be financed with short-term financing, which currently costs 7 percent. Lear鈥檚 earnings before interest and taxes are \)240,000. Determine Lear鈥檚 earnings after taxes under this financing plan. The tax rate is 30 percent.

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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.
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