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CHAPTER 6
Management
Problem 6-14

Hirt, and Danielsen

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 Foundations of Financial Management
Block, Hirt, and Danielsen

Problem 6-9
Objective: Short-term versus longer-term borrowing

Student Name:
Course Name:
Student ID:
Course Number:

Sauer Food Company has decided to buy a new computer system with an expected life of three years at a cost
of $150,000.The company can borrow $150,000 for three years at 10 percent annual interest or for one year at
8 percent annual interest.

a. How much would the firm save in interest over the three-year life of the computer system if the one-year loan is
utilized, and the loan is rolled over (reborrowed) each year at the same 8 percent rate? Compare this to the
10 percent three-year loan.

b. What if interest rates on the 8 percent loan go up to 13 percent in the second year and 18 percent in the third year?
What would be the total interest cost compared to the 10 percent, three-year loan?

Copyright © 2011 McGraw-Hill/ Irwin Spreadsheet Template by Block, Hirt and Danielsen Problem: 6-9
 Solution
Problem 6-9
Instructions
Complete the tables below with data and formulas.

Sauer Food Company

If Rates Are Constant:

Amount
Borrowed Rate Years Interest
3-year loan $150,000 FORMULA
1-year loan (rolled over) $150,000 FORMULA
Interest savings from borrowing short-term FORMULA

If Short-term Rates Change:

Amount
Borrowed Rate Interest
Year 1 $150,000 FORMULA
Year 2 $150,000 FORMULA
Year 3 $150,000 FORMULA
Total interest FORMULA

Extra interest costs associated with borrowing short-term FORMULA

Copyright © 2011 McGraw-Hill/ Irwin Spreadsheet Template by Block, Hirt and Danielsen Problem: 6-9
 Foundations of Financial Management
Block, Hirt, and Danielsen

Problem 6-10
Objective: Optimal policy mix

Student Name:
Course Name:
Student ID:
Course Number:

Assume that Hogan Surgical Instruments Co. has $2,500,000 in assets. If it goes with a low-liquidity plan for the
assets, it can earn a return of 18 percent, but with a high-liquidity plan, the return will be 14 percent.
If the firm goes with a short-term financing plan, the financing costs on the $2,500,000 will be 10 percent, and
with a long-term financing plan, the financing costs on the $2,500,000 will be 12 percent.
(Review Table 6–11 for parts a, b, and c of this problem.)

a. Compute the anticipated return after financing costs with the most aggressive asset-financing mix.

b. Compute the anticipated return after financing costs with the most conservative asset-financing mix.

c. Compute the anticipated return after financing costs with the two moderate approaches to the asset-financing mix.

d. Would you necessarily accept the plan with the highest return after financing costs? Briefly explain.

Copyright © 2011 McGraw-Hill/ Irwin Spreadsheet Template by Block, Hirt and Danielsen Problem: 6-10
 Solution
Problem 6-10
Instructions
Complete the tables below with data and formulas to calculate the anticipated return under each scenario.

a. Compute the anticipated return after financing costs on the most aggressive asset-financing mix.

Most aggressive Amounts Rate Return

Low liquidity/high return FORMULA
Short-term financing FORMULA
Anticipated return FORMULA

b. Compute the anticipated return after financing costs on the most conservative asset-financing mix.

Most conservative Amounts Rate Return

High liquidity/low return FORMULA
Long-term financing FORMULA
Anticipated return FORMULA

c. Compute the anticipated return after financing costs on the two moderate approaches to the
asset-financing mix.

Moderate approach Amounts Rate Return

Low liquidity FORMULA
Long-term financing FORMULA
Anticipated return FORMULA
OR

Amounts Rate Return

High liquidity FORMULA
Short-term financing FORMULA
Anticipated return FORMULA

d. Would you necessarily accept the plan with the highest return after financing costs? Briefly explain.

Copyright © 2011 McGraw-Hill/ Irwin Spreadsheet Template by Block, Hirt and Danielsen Problem: 6-10
 Foundations of Financial Management
Block, Hirt, and Danielsen

Problem 6-14
Objective: Conservative versus aggressive financing

Student Name:
Course Name:
Student ID:
Course Number:

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.

a. Construct two alternative financing plans for the firm. One of the plans should be conservative, with 75 percent of
assets financed by long-term sources and the rest financed by short-term sources.
The other plan should be aggressive, with only 56.25 percent of assets financed by long-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 Guardian’s earnings before interest and taxes are $200,000, calculate earnings after taxes for
each of your alternatives.

Copyright © 2011 McGraw-Hill/ Irwin Spreadsheet Template by Block, Hirt and Danielsen Problem: 6-14
 Solution
Problem 6-14
Instructions
Complete the templates below to solve the requirements of this problem.

Temporary current assets

Permanent current assets
Fixed assets
Total assets FORMULA
a.
Conservative Amount % of Dollar Interest Interest
Total Amount Rate Expense
Long-term sources FORMULA 75% FORMULA 15% FORMULA
Short-term sources FORMULA 25% FORMULA 10% FORMULA

Total interest charge FORMULA

Aggressive Amount % of Dollar Interest Interest

Total Amount Rate Expense
Long-term sources FORMULA 56.25% FORMULA 15% FORMULA
Short-term sources FORMULA 43.75% FORMULA 10% FORMULA

Total interest charge FORMULA

b. Conservative Aggressive
EBIT
Less: Interest FORMULA FORMULA
EBT FORMULA FORMULA
Tax (40%) FORMULA FORMULA
EAT FORMULA FORMULA

Copyright © 2011 McGraw-Hill/ Irwin Spreadsheet Template by Block, Hirt and Danielsen Problem: 6-14