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Chapter 3: Q7DQ (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, resulting in higher profits for the organization.

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Most popular questions from this chapter

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?

Eastern Auto Parts Inc. has 15 percent of its sales paid for in cash and 85 percent on credit. All credit accounts are collected in the following month. Assume the following sales:

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\(65,000

February

\)55,000

March

\(100,000

April

\)45,000

Sales in December of the prior year were $75,000. Prepare a cash receipts schedule for January through April.

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c. What will the average inventory be?

What are the 5 Cs of credit that are sometimes used by bankers and others to determine whether a potential loan will be repaid?

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.
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