C assuming that short term funds cost 12 annually and

This preview shows page 134 - 138 out of 155 pages.

c.Assuming that short-term funds cost 12% annually and that the cost of long-term funds is 17% annually, use the averages found in part ato calculate the total cost of each of the strategies described in part b.d.Discuss the profitability-risk tradeoffs associated with the aggressive strategy and those associated with the conservative strategy.Solution:(a)MonthTotal FundsRequirementsPermanentRequirementsSeasonalRequirementsJanuary$2,000,000$2,000,000$0February2,000,0002,000,0000March2,000,0002,000,0000April4,000,0002,000,0002,000,000May6,000,0002,000,0004,000,000June9,000,0002,000,0007,000,000July12,000,0002,000,00010,000,000August14,000,0002,000,00012,000,000September9,000,0002,000,0007,000,000October5,000,0002,000,0003,000,000November4,000,0002,000,0002,000,000December3,000,0002,000,0001,000,000134
Average permanent requirement$2,000,000Average seasonal requirement$48,000,000  12$4,000,000(b)(1)Under an aggressive strategy, the firm would borrow from $1,000,000 to $12,000,000 according to the seasonal requirement schedule shown in (a) at theprevailing short-term rate. The firm would borrow $2,000,000, or the permanent portion of its requirements, at the prevailing long-term rate.(2)Under a conservative strategy, the firm would borrow at the peak need level of $14,000,000 at the prevailing long-term rate.(c)Aggressive($2,000,000  0.17)  ($4,000,000  0.12)$340,000  $480,000$820,000Conservative($14,000,000  0.17)$2,380,000(d)In this case, the large difference in financing costs makes the aggressive strategy more attractive. Possibly the higher returns warrant higher risks. In general, since the conservative strategy requires the firm to pay interest on unneeded funds, its costis higher. Thus, the aggressive strategy is more profitable but also more risky.135
Example 40:Ethics problem (Source: Gitman, 2006).Controlled disbursing is defined as an information product --- that is, the bank on which the company’s checks are drawn provides an early-morning notification of the total dollar amount of checks that will clear the account that day. Based on that notification, the company may then fundthe account for that amount by the close of business that afternoon. How might controlled disbursing still be viewed as a form of “remote disbursing,” and therefore be considered unethical?Solution: Controlled disbursement accounts located at banks very distant from the company’s payables staff, headquarters, and other offices are suspect. This really puts it into the realm of “remote disbursement,” especially when the account is located in an out-of-the-way locale.136
Example 41: Credit terms (Source: Gitman, 2006).Purchases made on credit are due in full by the end of the billing period. Many firms extend adiscount for payment made in the first part of the billing period. The original invoice contains atype of “short hand” notation that explains the credit terms that apply. (Note: Assume a 365 dayyear).a. Write the short-hand expression of credit terms for each of the following.Cash discountCash discount periodCredit periodBeginning of creditperiod1%15 days45 daysDate of invoice2%10 days30 daysEnd of month2%7 days28 daysDate of invoice1%10 days60 daysEnd of monthb. For each of the sets of credit terms in part a, calculate the number of days until full payment is due for invoices dated March 12.

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture