Tiffany & Assoc. is devolping an asset financing plan. Tiffany has $1,000,000 in

Question

Tiffany & Assoc. is devolping an asset financing plan.  Tiffany 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%.  Tiffany & Assoc. tax rate is 30%.

a.  Construct two financing plans-one conservative, with 80% of assets financed by long-term sources, and the other aggresive, with only 60% of assets financed by long-term sources.  If Tiffany'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 yeild curve is steeply inverted, which financing plan should Tiffany's choose?

Explanation / Answer

Tiffany & Assoc. is devolping an asset financing plan. Tiffany 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%. Tiffany & Assoc. tax rate is 30%.

a. Construct two financing plans-one conservative, with 80% of assets financed by long-term sources, and the other aggresive, with only 60% of assets financed by long-term sources. If Tiffany'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 yeild curve is steeply inverted, which financing plan should Tiffany's choose?

Plan 1 - 80% Financed by long term sources:
Total Investment
80%

Assets 1000000
1000000*80%=800000

9%----Long term Interest Rate

Interest amount for 80% investment

800000 * 9%=$72,000

Interest on 20% Investment

200000 * 6.5% =$13,000

$72,000+$13,000 =$85,000=======Total Interest Expence per year

=============================================================
Plan 2 - 60% Financed by long term sources:

Total Investment

60% of Assets 1000000=

1000000*60%=600000

9%---------Long term Interest Rate

Interest amount for 60% investment

600000 * 9%

Interest on 40% Investment

400000 * 6.5%

$54,000

Total Interest expense per year(79200 + 40800)

$26,000
$80,000

b)
Plan - 1

Income Before Interest & Tax=525000
Interest as per plan - 1=$85,000
Income after interest=$440,000
Tax=$176,000
Net Income=$264,000

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