CASE 3 (20 points)

Lake Corporation has 950,000 in current assets, out of which 425,000 are considered permanent current assets. In addition, the firm has 750,000 invested in fixed assets. The company has two financing plans under consideration:

Plan 1: Lake wishes to finance all fixed assets and half of its permanent current assets with long-term financing costing 10 percent. The balance will be financed with short-term financing, which currently costs 6 percent. Lakes earnings before interest and taxes are 350,000. The tax rate is 40 percent.

Plan 2: As an alternative, Lake might wish to finance all fixed assets and permanent current assets plus half of its temporary current assets with long-term financing and the balance with short-term financing. Earnings before interest and taxes will be 350,000. The same tax rate and interest rates apply as in Plan 1.

Instructions:

1. Determine Lakes earnings after taxes under each financing plan. (10 points)

2. Which plan should Lake choose? Justify. (5 points)

3. What are some of the risks and cost considerations associated with each of these financing plans? (5 points)

CASE 4 (25 points)

Harper Corporation needs 750,000 to take a cash discount of 5/15, net 40. A banker will loan the money for 25 days at an interest cost of 19,100. Assume a 360-day year for your calculations.

Instructions:

1. What is the effective rate on the bank loan? (5 points)

2. How much would it cost (in percentage terms) if Harper did not take the cash discount, but paid the bill in 40 days instead of 15 days? (5 points)

3. Should Harper borrow the money to take the discount? Explain. (5 points)

4. If another banker requires a 20 percent compensating balance, how much must Harper borrow to end up with 750,000? (5 points)

5. What would be the effective interest rate in part d if the interest charge for 25 days were 13,300? Since there are no funds to count against the compensating balance requirement, should Harper borrow with the 20 percent compensating balance? (5 points)