Changing Levels of Current Liabilities

Firm B has the following levels of assets, liabilities, and equity:

Assets Liabilities and Equity

Current Assets $20,000 Current Liabilities $10,000

Fixed Assets 42,000 Long-term Debt 37,000

Total 62,000 Equity 15,000

Total 62,000

The firms current liabilities cost approximately 4% annually to maintain, and the average annual cost of its long-term funds is 15%.

Calculate the firms initial values of 1) the ratio of current liabilities to total assets, 2) the annual cost of financing, and 3) net working capital.

If the firm shifts $5,000 of current liabilities to long-term funds, find the value of 1) the ratio of current liabilities to total assets, 2) the annual cost of financing, and 3) net working capital.

Returning to the original balance sheet, assume the firm shifts $5,000 of long-term funds to current liabilities, find the value of 1) the ratio of current liabilities to total assets, and 2) the annual cost of financing, and 3) net working capital.

Summarize your findings by describing the relationship between risk and return and the three different liability structures found in a, b, and c.