16-14A. (Analysis ofrecessirmary cash flows) Cavalier Agriculture Supplies is Wldertaking a thorough cash flow analysis. It has been proposed by management that the firm expand by raising $5 million in the long-term debt markets. All of this would be immediately invested in new fixed assets. The proposed bond issue would carry an 8 percent interest rate and have a maturity period of20years.

The bond issue would have a sinking fund provision that one-twentieth of the principal would be retired annually. Next year is expected to be a poor one for Cavalier. The firm's management feels, therefore, that the upcoming year would serve well as a model for the worst possible operating conditions that the finn can be expected to encoWlter. Cavalier ordinarily carries a $500,000 cash bal·

ance. Next year sales collections are forecast to be $3 million. Miscellaneous cash receipts will total

$200,000. Wages and salaries will amoWlt to $1 million. Payments for raw materials used in the production process will be $1,400,000. In addition, the firm will pay $500,000 in nondiscretionary expenditures including taxes. The finn faces a 50 percent tax rate.

a. Cavalier currently has no debt or preferred stock outstanding. What will be the total fixed financial charges that the firm must meet next year?

b. What is the expected cash balance at the end of the recessionary period (next year), assuming the debt is issued?

c. Based on this information, should Cavalier issue the proposed bonds?