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6.) Assume that Hogan Surgical Instruments co. has $2,000,000 in assets. If its 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 $2,000,000 will be 10 percent, and with a long-term financing plan, the financing costs on the $2,000,000 will be 12 percent. (Review Table 6-11 for parts a, b, and c of this problem. which is attached in the Word document)

a. compute the anticipated return after financing costs with the most agressive 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.

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a. compute the anticipated return after financing costs with the most agressive asset-financing mix.
Low liquididty and short term financing

Assets

$2,000,000

Return on assets @ 18% = $360,000 =18%*2000000

Financing cost @ 10% = $200,000 =10%*2000000

Profit= $160,000 =360000-200000

Return in %= 8.00% =160000/2000000

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

High liquididty and long ...

Solution Summary

The solution computes the anticipated return for most agressive asset-financing mix, most conservative asset-financing mix and for two moderate approaches to the asset-financing mix. Thus the anticipated returns are calculated for Low liquididty and short term financing, High liquididty and long term financing, High liquididty and short term financing, Low liquididty and long term financing.

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16. Building Financial Models. The following tables contain financial statements for Dynastatics Corporation. Although the company has not been growing, it now plans to expand and will increase net fixed assets (that is, assets net of depreciation) by $200,000 per year for the next 5 years and forecasts that the ratio of revenues to total assets will remain at 1.50. Annual depreciation is 10 percent of net fixed assets at the end of the year. Fixed costs are expected to remain at $56,000 and variable costs at 80 percent of revenue. The company's policy is to pay out two-thirds of net income as dividends and to maintain a book debt ratio of 25 percent of total capital.

INCOME STATEMENT, 2006
(figures in thousands of dollars)

Revenue $1,800
Fixed costs 56
Variable costs (80% of revenue) 1,440
Depreciation 80
Interest (8% of beginning-of-year debt) 24
Taxable income 200
Taxes (at 40%) 80
Net income $120
Dividends $80
Retained earnings $40

BALANCE SHEET,YEAR-END
(figures in thousands of dollars)
2006
Assets
Net working capital $400
Fixed assets 800
Total assets $1,200
Liabilities and shareholders' equity
Debt $300
Equity 900
Total liabilities and
shareholders' equity $1,200

a. Produce a set of financial statements for 2007. Assume that net working capital will equal 50 percent of fixed assets.
b. Now assume that the balancing item is debt and that no equity is to be issued. Prepare a completed pro forma balance sheet for 2007. What is the projected debt ratio for 2007?

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