Conservative versus aggressive financing
Collins Systems, Inc., is trying to develop an asset-financing plan. The firm has $300,000 in temporary current assets and $200,000 in permanent current assets. Collins also has $400,000 in fixed assets.
a. Construct two alternative financing plans for the firm. One of the plans should be conservative, with 80 percent of assets financed by long-term sources and the rest financed by short-term sources. The other plan should be aggressive, with only 30 percent of assets financed by long-term sources and the remaining assets financed by short-term sources. The current interest rate is 15 percent on long-term funds and 10 percent on short-term financing. Compute the annual interest payments under each plan.
b.Given that Collins’s earnings before interest and taxes are $180,000, calculate earnings after taxes for each of your alternatives. Assume a tax rate of 40 percent.