I have the answers to problems 1-4, but am having trouble on #5.

F305 Short Term Financial Policy Case Study 1 Background Firms with seasonal sales patterns often experience unique challenges in financing run-ups of assets. For example, a lawn-care firm might need to double its investment in working capitalsuch as seed, fertilizer and incidental cashin March as the busy summer lawn-care season approaches. Also, perhaps even more importantly, the firm will need to finance a buildup of accounts receivable unless it operates on an all cash basis. Conversely, in November, the firm will (hopefully!!) have shed its \"excess\" working capital as it has sold off its inventory, liquidated its receivables and distributed cash to its investors. Note, however, that the firm will likely still have \"permanent\" financing needs related to its Fixed Assetsin this case, perhaps, the loans and equity support for mowers, core aerators, trucks, etc. In a case such as the one above, financial managers are faced with a short-term financing decision: \"how do I finance seasonal buildups of working capital?\" How managers choose to do this depends upon many factorsand is part of the firm's financial and business strategy. It's also the topic of this case. A Few Basic Principles & Definitions When faced with decisions like the one above, financial managers apply some universal principles: The Hedging Principle // the cash-flow producing characteristics of an asset should be matched with the maturity of the financing of used to support it. For instance, inventory (which tends to sell quickly) should be financed with short-term financing. The Yield Curve Principle // the effective cost of long-term financing is generally higher than the effective cost of short-term financing. In general, the shorter the maturity of a method of financing, the less costly it is on an annualized basis. This, of course, assumes that the risk of the assets being financed is similar. Risk-Return Principle // Financial managers will take on more risk only if they expect to earn more return. Note that the converse of this is true as well: taking a \"conservative\" or \"safe\" position generally means a lower rate of return, however defined. Some key definitions used in short-term financial management are: Conservative Financing // using long-term (long maturity) sources of financing to acquire assets. Note that this is not an absolute term: rather, it is comparative. For example, a firm's financing policy can be said to be more \"conservative\" than another's. Aggressive Financing // using short-term sources of financing to acquire assets, particularly current assets. For example, rather than arranging a 6-month line of credit to buy inventory, a firm could simply accept a 30-day invoice from its suppliers. The above caveat regarding the comparative nature of the term applies here as well. Spontaneous Financing // financing that more or less arises automatically in response to the purchase of an asset. For example, when supplies are bought on account, the financing is more or less automatic. Another good example is accrued wages: when a firm has a weekly wage expense of $10,000 but pays its employees monthly, $40,000 of spontaneous financing is generated. Factoring // Selling Accounts Receivable to a third party at a discount from face value. For example, if $100 of receivables is sold at a 3% discount, the seller receives $97 in cash. Note that in this case, the periodic cost of financing is 3/97 = 3.1% per period. Effective Annual Rate (EAR) // the annualized cost of financing including the effect of compounding. In general, the following formula can be used to calculate EAR: EAR = (1 + i) m - 1, where i = periodic rate of return and m = number of annual compounding periods. Case: The St. Hubbins Plumbing Company The St. Hubbins Plumbing Company (SHPC) is a supplier of plumbing related goods and services to the commercial construction industry. Primarily, it serves as a subcontractor in the construction of smallscale retail strip centers. Since the bulk of retail center construction occurs in the Spring & Summer months (primarily from late March to late September) SHPC has a rather seasonal (but predictable) pattern of working capital needs, as summarized by the following table: Table 1 Permanent Financing Needs Used to finance Fixed Assets + Permanent Working Capital Peak Financing Needs Includes the above + maximum seasonal Working Capital Average Financing Needs The average size of the firm's balance sheet over a 12month period Buildup of Accounts Receivable Terms: Net 90 Days $1.25 Million $3.25 Million $2.45 Million 50% of Seasonal Buildup The financing and investment options available to SHPC are summarized as follows: Table 2 Financing Trade Credit / Accrued Wages with 30-day maturity 6-month line of credit from First Plumber's Bank 10-year note from Second National Factoring of Receivables Issuance of New Equity Rate of Return on Money Market Securities Periodic Cost 0% 2.25% per 6 months 6.75% per year 2.5% of face value 15% per year .15% per month Table 3 As the CFO of SHPC, you are considering 3 possible financing plans for the next fiscal year: Plan X Finance 50% of permanent need with Equity Finance 50% of permanent need with a 10-year note Plan Y Finance 100% of permanent need with Equity Factor Receivables Finance 50% of seasonal need with Trade Credit Finance remainder of seasonal need a 6-month line of credit Finance the remainder of seasonal need with a 6-month line of credit Plan Z Finance 100% of permanent need with Equity Finance all other needsup to the Total Peak Need with a 10-year note Re-invest any excess funds in Money Market Securities Tasks 1. Use Table 1 to calculate both the peak and average SEASONAL financing needs. 2. Calculate the EAR for each financing source listed in Table 2. 3. For each financing plan in Table 3, calculate the dollar amount of financing supported by each source. 4. For Plan Z, calculate the dollar amount of funds available for re-investment on an average annual basis 5. Use your calculations in 1 - 4 above to calculate BOTH the annual dollar financing cost AND the Cost of Capital (a percentage) for each financing plan listed in Table 3