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Chapter 3: Q8BP (page 157)

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?

Short Answer

Expert verified

The fixed-cost financing plan is a less costly financing option for the company.

Step by step solution

01

Information given in the question

The following information is provided:

Financing required in next three years = $550,000

Cost of financing = 10.60% per annum

The interest rate on short-term financing inthefirst year = 8.75% per annum

The interest rate on short-term financing inthesecond year = 13.25% per annum

The interest rate on short-term financing in the third year = 10.15% per annum

02

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

The cost of financing is $174,900.

Costoffinancing=Borrowedfunds脳Interestrate脳Time=($550,000脳$10.60%p.a.脳3)=$174,900

03

Cost of financing using short-term financing

The cost of financing is $176,825.

Costoffinancing=Borrowedfunds脳Interestrate脳Time=($550,000脳$8.75%p.a.脳1)=($550,000脳$13.5%p.a.脳1)=($550,000脳$10.5%p.a.脳1)=$48,125+脳$72,875+$55,825=$176,825

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Most popular questions from this chapter

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.

b. Given that Guardian鈥檚 earnings before interest and taxes are \)200,000, calculate earnings after taxes for each of your alternatives.

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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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.)

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

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March

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January

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$375,000

100%
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