Assume that Hogan Surgical Instruments Co. has $2,500,000 in assets. If it goes

Question

Assume that Hogan Surgical Instruments Co. has $2,500,000 in assets. If it 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 $2,500,000 will be 10 percent, and with a long-term financing plan, the financing costs on the $2,500,000 will be 12 percent. Compute the anticipated return after financing costs with the most aggressive asset-financing mix. Compute the anticipated return after financing costs with the most conservative asset-financing mix. Compute the anticipated return after financing costs with the two moderate approaches to the asset-financing mix.

Explanation / Answer

Solution-a

Most aggressive

Low liquidity = $2,500,000 *18%

Low liquidity = $450,000

Short-term financing = -$2,500,000*10%

Short-term financing = -$250,000

Anticipated return = $450,000 + (-$250,000)

Anticipated return = $200,000

Solution-b

Most conservative

High liquidity = $2,500,000 *14%

High liquidity = $350,000

Long-term financing = –$2,500,000 * 12%

Long-term financing = -$300,000

Anticipated return = $350,000 + (-$300,000)

Anticipated return = $50,000

Solution-c

Moderate approach

Low liquidity = $2,500,000 *18%

Low liquidity = $450,000

Long-term financing =–$2,500,000 * 12%

Long-term financing = -$300,000

Anticipated return = $450,000 + (-$300,000)

Anticipated return = $150,000

Moderate approach

High liquidity = $2,500,000 *14%

High liquidity = $350,000

Short-term financing = -$2,500,000*10%

Short-term financing = -$250,000

Anticipated return = $350,000 + (-$250,000)

Anticipated return = $100,000

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