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    Aggressive vs. Conservative Financing

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    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.

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    https://brainmass.com/business/interest-rates/aggressive-vs-conservative-financing-572504

    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