Using the data on the firms total funds requirements

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Unformatted text preview: long-term funds and finance the remaining funds requirements with short-term funds. Using the data on the firm’s total funds requirements, Morton estimated the average annual short-term and long-term financing requirements for each strategy in the coming year, as shown in the following table. Average annual financing Type of financing Strategy 1 (aggressive) Short-term $2,500,000 Long-term 1,000,000 Strategy 2 (conservative) $ Strategy 3 (tradeoff) 0 $1,666,667 7,000,000 3,000,000 To ensure that, along with spontaneous financing from accounts payable and accruals, adequate short-term financing will be available, Morton plans to establish an unsecured short-term borrowing arrangement with its local bank, 666 PART 5 Short-Term Financial Decisions Third National. The bank has offered either a line-of-credit agreement or a revolving credit agreement. Third National’s terms for a line of credit are an interest rate of 2.50% above the prime rate, and the borrowing must be reduced to zero for a 30-day period during the year. On an equivalent revolving credit agreement, the interest rate would be 3.00% above prime with a commitment fee of 0.50% on the average unused balance. Under both loans, a compensating balance equal to 20% of the amount borrowed would be required. The prime rate is currently 7%. Both the line-of-credit agreement and the revolving credit agreement would have borrowing limits of $1,000,000. For purposes of his analysis, Morton estimates that Kanton will borrow $600,000 on the average during the year, regardless which financing strategy and loan arrangement it chooses. Required a. Determine the total annual cost of each of the three possible financing strategies. b. Assuming that the firm expects its current assets to total $4 million throughout the year, determine the average amount of net working capital under each financing strategy. (Hint: Current liabilities equal average short-term financing.) c. Using the net working capital found in part b as a measure of risk, discuss...
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