Chapter 06: Working Capital and the Financing Decision
6-15. (Continued)
b. Alternative financing plan
Long-term interest expense = 8% [$640,000 + $370,000
+ ½($470,000)]
c. The alternative financing plan, which calls for more
financing by high-cost debt, is more expensive and reduces
aftertax income by $2,940. However, we must not
16. Expectations hypothesis and interest rates (LO4) Using the expectations hypothesis
theory for the term structure of interest rates, determine the expected return for securities
Chapter 06: Working Capital and the Financing Decision
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 beginning of year 1 6%
1-year T-bill at beginning of year 2 7%
1-year T-bill at beginning of year 3 9%
1-year T-bill at beginning of year 4 11%
6-16. Solution:
17. Expectations hypothesis and interest rates (LO4) 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 the right-hand portion of Table 6-6.
1-year T-bill at beginning of year 1…… 5%
1-year T-bill at beginning of year 2…… 8%
1-year T-bill at beginning of year 3…… 7%
1-year T-bill at beginning of year 4…… 10%
6-17. Solution:
18. Interest costs under alternative plans (LO3) Carmen’s Beauty Salon has estimated
monthly financing requirements for the next six months as follows:
January…………….. $8,500 April……………… $8,500
February…….…..... 2,500 May….….….….... 9,500
March.……………… 3,500 June…………….... 4,500
Short-term financing will be utilized for the next six months. Projected annual interest
rates:
January…………….. 9.0% April……………… 16.0%
February…….…..... 10.0% May…….….…..... 12.0%
Chapter 06: Working Capital and the Financing Decision
March.……………… 13.0% June…………….... 12.0%
a. Compute total dollar interest payments for the six months. To convert an annual rate
to a monthly rate, divide by 12. Then, multiply this value times the monthly balance. To
get your answer, add up the monthly interest payments.
Chapter 06: Working Capital and the Financing Decision
b. If long-term financing at 12 percent had been utilized throughout the six months, would
the total-dollar interest payments be larger or smaller? Compute the interest owed over
the six months and compare your answer to that in part a.
6-18. Solution:
Carmen’s Beauty Salon
a. Short-term financing
Month Rate
On Monthly
Basis Amount
Actual
Interest
6-18. (Continued)
b. Long-term financing
Month Rate
On Monthly
Basis Amount
Actual
Interest
19. Break-even point in interest rates (LO3) 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.)
6-19. Solution:
Carmen’s Beauty Salon (Continued)
Chapter 06: Working Capital and the Financing Decision
6-20. Solution:
Eastern Auto Parts
Jan Feb Mar Apr
21. Level production and related financing effects (LO3) Bombs Away Video Games
Corporation has forecasted the following monthly sales:
January…..…...... $100,000 July……..…... $ 45,000
February……...... 93,000 August…...... 45,000
March…..….….... 25,000 September... 55,000
April….….….…... 25,000 October…….. 85,000
May….….….….... 20,000 November…. 105,000
June….….….….... 35,000 December.... 123,000
Total annual sales = $756,000
Bombs Away Video Games sells the popular Strafe and Capture video game. It sells for
$5 per unit and costs $2 per unit to produce. A level production policy is followed. Each
month’s production is equal to annual sales (in units) divided by 12.
Of each month’s 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.)
b. Prepare a monthly schedule of cash receipts. Sales in the December before the planning
year are $100,000. Work part b using dollars.
c. Determine a cash payments schedule for January through December. The production
costs of $2 per unit are paid for in the month in which they occur. Other cash payments,
besides those for production costs, are $45,000 per month.
Chapter 06: Working Capital and the Financing Decision
d. Prepare a monthly cash budget for January through December using the cash receipts
schedule from part b and the cash payments schedule from part c. The beginning cash
balance is $5,000, which is also the minimum desired.
6-21. Solution:
Bombs Away Video Games Corporation
a. Production and inventory schedule in units
Beginnin
g
Inventory + Production1– Sales2=
Ending
Inventor
y
Jan. 25,000 +12,600 – 20,000 =17,600
Feb. 17,600 +12,600 – 18,600 =11,600
Chapter 06: Working Capital and the Financing Decision
6-21. (Continued)
b.
Bombs Away Video Games Corporation
Cash Receipts Schedule
Jan.Feb.Mar.Apr.May June
Chapter 06: Working Capital and the Financing Decision
6-21. (Continued)
c.
Bombs Away Video Games Corporation
Cash Payments Schedule
Constant Production
Jan. Feb. Mar. Apr. May June
July Aug. Sept. Oct. Nov. Dec.
Chapter 06: Working Capital and the Financing Decision
6-21. (Continued)
d.
Bombs Away Video Games Corporation
Cash Budget
Jan. Feb. Mar. Apr. May June
Chapter 06: Working Capital and the Financing Decision