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Chapter 3: 7DQ (page 182)

A firm that uses short-term financing methods for a portion of permanent current assets is assuming more risk but expects higher returns than a firm with a normal financing plan. Explain.

Short Answer

Expert verified

Short-term financing is available at lower interest rates than that of long-term financing resultingin higher profits for the organization.

Step by step solution

01

Meaning of short-term financing

Short-term financing is the process of using different sources of finance for obtaining finance for less than one year. This method is usually used to meet the working capital requirements of the organization.

02

The explanation of the given statement

Short-term financing is offered at lower interest rates than the sources of long-term financing. If this method is used for permanent assets, it would be risky as the finance may not available at all times,but the cost of this method of financing will be low,resultingin higher profits for the organization.

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Most popular questions from this chapter

Summit Record Company is negotiating with two banks for a \(151,000 loan. Fidelity Bank requires a 28 percent compensating balance, discounts the loan, and wants to be paid back in four quarterly payments. Southwest Bank requires a 14 percent compensating balance, does not discount the loan, but wants to be paid back in 12 monthly installments. The stated rate for both banks is 10 percent. Compensating balances will be subtracted from the \)151,000 in determining the available funds in part a.

c. Does your choice of banks change if the assumption in part b is correct?

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.

c. What would happen if the short- and long-term rates were reversed?

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

a. Fill in column (4) for each month.

Age of receivables April 30 20X1

1

2

3

4

Month of sales

Age of accounts

Amounts

Percent of amount due

April

0-30

\(131,250

____

March

31-60

\)93,750

____

February

61-90

\(112,500

____

January

91-120

\)37,500

____

Total receivables

$375,000

100%

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.

a. If City Farm has \(5 million per day in collections and \)3 million per day in disbursements, how many dollars has the cash management system freed up?

What does the term structure of interest rates indicate?
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