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Chapter 3: Q19BP (page 188)

In Problem 18, what long-term interest rate would represent a break-even point between using short-term financing as described in part a and long-term financing? (Hint: Divide the interest payments in 18a by the amount of total funds provided for the six months and multiply by 12.)

Short Answer

Expert verified

The monthly interest rate will be 1.014%, and 12.17% will be the annual interest rate.

Step by step solution

01

Interest payments

January

$8,500

February

$2,500

March

$3,500

April

$8,500

May

$9,500

June

$4,500

02

Calculation of break-even point

The break-even point will be 1.014% monthly rate and 12.17% annual rate.

Break-evenpoint=InterestPrinciple=$373.35$37,000=1.014%

AnnualInterestRate=Monthlyinterestrate脳12=1.014%脳12=12.17%

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Most popular questions from this chapter

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 games. 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.

a. Construct a monthly production and inventory schedule in units. Beginning inventory in January is 25,000 units. (Note: To do part a, you should work in terms of units of production and units of sales.)

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?

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.

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 and the balance with short-term financing. The same interest rates apply as in part a. Earnings before interest and taxes will be $240,000. What will be Lear鈥檚 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?

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%

Henderson Office Supply is considering a more liberal credit policy to increase sales, but expects that 9 percent of the new accounts will be uncollectible. Collection costs are 6 percent of new sales, production and selling costs are 74 percent, and accounts receivable turnover is four times. Assume income taxes of 20 percent and an increase in sales of $65,000. No other asset build-up will be required to service the new accounts.

a. What is the level of accounts receivable to support this sales expansion?
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