Educational Toys, Inc. (ETI) has highly seasonal sales and financing requirements.

The company’s balance sheet on December 31, 2009, is as follows:

Assets

(in Millions of Dollars)

Liabilities and Equity

(in Millions of Dollars)

Short-term debt $ x Current assets $20 Long-term debt y Fixed assets 34 Net worth (equity) 30 Total assets $54 Total liabilities and equity $54 ETI has made the following projections of its asset needs and net additions to retained earnings (that is, equity) for the next 3 years:

Assuming that ETI does not plan to sell any preferred or new common stock over the next 3 years:

a. Determine ETI’s quarterly total assets and total (short-term and long-term)
debt requirements for the next 3 years.

b. Plot the firm’s fixed, current, and total assets over time on a graph.

c. Assume that ETI follows a matching approach in financing its assets. In other words, long-term debt will be used to finance its fixed and permanent current assets, and short-term debt will be used to finance its fluctuating current assets. The costs of short-term and long-term debt to ETI under this plan are 6 and 8 percent per annum (i.e., 1.5 and 2 percent per quarter), respectively. Using this information, determine the following:
i. The amount of short-term and long-term debt outstanding each quarter.
•ii. ETI’s total interest costs over the 3-year period under this approach

d. ETI is also considering other financing plans. One plan under consideration is a conservative policy. Under this policy, the company would determine its maximum debt requirements for the coming year and finance this entire amount with long-term debt at an interest rate of 8 percent per annum on December 31 of each year. Any funds in excess of its seasonal (quarterly)
needs would be invested in short-term interest-bearing securities to yield a 4 percent per annum rate of return. Using this information, determine the following:
i. The amount of long-term debt ETI would have to borrow each year ii. ETI’s net interest costs over the 3-year period under this conservative policy

e. Finally, ETI is also considering an aggressive policy. Under this policy, the company would determine its minimum debt requirements for the coming year on December 31 of each year and finance one-half of this amount with long-term debt, with the remainder being financed by short-term debt. The costs of short-term and long-term debt under this policy are 6 and 8 percent per annum, respectively. Using this information, determine the following:
i. The amount of short-term and long-term debt outstanding each quarter ii. ETI’s total interest costs over the 3-year period under this aggressive policy LO1