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Aggressive vs. Conservative Financing

Here is my assignment and my answers. I need to know if my answers are correct and if not where I made mistakes. Please and thank you!

1. McKinsee Inc. is developing a plan to finance its asset base. The firm has $5,000,000 in current assets, of which 20% are permanent, and $12,000,000 in fixed assets. Long-term rates are currently 9.5%, while short-term rates are at 7%. McKinsee's tax rate is 30%.

a) Construct a conservative financing plan with 80% of assets financed by long-term sources. If McK's earnings before interest and taxes are $6,000,000, what will their net income be?
My answer to a)

Calculate the net income: To calculate the net income, find the value of total assets.
Total assets = Current assets + Fixed assets= $5,000,000 + $12,000,000 = $17,000,000
If 80% of the total assets are financed, then the amount of debt would be Debt = 80% *assets = 80% * 17,000,000 = $13,600,000
If the debt is financed with long term rate, then the interest amount would be calculated as Interest amount = 9.5%*13600000 = $1292000
Therefore, the interest expense is $1292000 when 80% of the assets are financed with long-term sources.
So Net income will be as below:
EBIT 6,000,000
Less Int 1292000
EBT 4708000
Less Tax 30% 1412400
Net Income 3295600

b) An alternative and more aggressive plan would be to finance 60% of total assets with long-term financing. Assuming that EBIT was again $6,000,000, what will net income be under this alternative?
My answer to b)

Calculate the net income: Same as above = $17,000,000
If 60% of the total assets are financed, then the amount of debt would be Debt = 60% *assets = 60% * 17,000,000 = $10200000
If the debt is financed with long term rate, then the interest amount would be calculated as
Interest amount = 9.5%*10200000 = $969000.
therefore, the interest expense is $969000 when 60% of the assets are financed with long-term sources.
So Net income will be as below:
EBIT 6,000,000
Less Int 969000
EBT 5031000
Less Tax 30% 1509300
Net Income 3521700

My answer to c)
c)If the yield curve is sloping upward, then the second option is recommended.

Solution Summary

The solution is provided in an Excel sheet where I used cell references to calculate net income under both the aggressive and the conservative financing plans.

$2.19