2. Christensen & Assoc. is developing an asset financing plan. Christensen has $

ID: 2650801 • Letter: 2

Question

2. Christensen & Assoc. is developing an asset financing plan. Christensen has $1,000,000 in current assets, of which 15% are permanent, and $700,000 in fixed assets. The current long-term rate is 9%, and the current short-term rate is 6.5%. Christensen's tax rate is 30%.

a) Construct two financing plans-one conservative, with 80% of assets financed by long-term sources, and the other aggressive, with only 60% of assets financed by long-term sources. If Christensen's earnings before interest and taxes are $525,000, calculate net income under each alternative.
b) What are some of the risks associated with each plan?
c) If the yield curve is steeply inverted, which financing plan should Christensen choose?

Explanation / Answer

1,700,000 * 0.80 = 1360000 * 0.09 = 122400

1,700,000 * 0.20 = 340000 *.065 = 22100

122400 + 22100 = 144500

Aggressive = 60%

1,700,000 * 0.60 = 1020000 *0.09 = 91800

1,700,000 * 0.40 = 680000 * .065 = 44200

91800 + 44200 = 136000

conservative

Aggressive

EBIT

525000

- Interest

144500

136000

EBT

380500

389000

Tax 30%

114150

116700

EAT

266350

272300