Question

Assume that Atlas Sporting Goods Inc. has $850,000 in assets. If it goes with a low-liquidity plan for the assets, it can earn a return of 16 percent, but with a high-liquidity plan the return will be 13 percent. If the firm goes with a short-term financing plan, the financing costs on the $850,000 will be 10 percent, and with a long-term financing plan, the financing costs on the $850,000 will be 12 percent.

a. Compute the anticipated return after financing costs with the most aggressive asset-financing mix.

b. Compute the anticipated return after financing costs with the most conservative asset-financing mix.

c. Compute the anticipated return after financing costs with the two moderate approaches to the asset-financing mix.

d. If the firm used the most aggressive asset-financing mix described in part a and had the anticipated return you computed for part a, what would earnings per share be if the tax rate on the anticipated return was 30 percent and there were 20,000 shares outstanding? (Round your answer to 2 decimal places.)

e-1. Now assume the most conservative asset-financing mix described in part b will be utilized. The tax rate will be 30 percent. Also assume there will only be 5,000 shares outstanding. What will earnings per share be? (Round your answer to 2 decimal places.)

e-2. Would the conservative mix have higher or lower earnings per share than the aggressive mix? Lower Higher

Answer 1

(1) Computation of anticipated return after financing costs with the most aggressive asset-financing mix:

Most aggressive asset-financing mix would mean going with a low liquidity plan for assets with long term financing. As the term suggests, it implies investment is dominantly been done on acquiring capital assets from long term financing as the amount is huge. Therefore, this strategy can earn a return of 16% and financing cost being 12% for long term financing.

Therefore, net return with this strategy = Return of 16% minus Cost of 12% = 4%

Return = 850,000 * 4% = $ 34,000

(2) Computation of anticipated return after financing costs with the most conservative asset-financing mix:

As seen from the aggressive approach, it can be determined that a most conservative asset -financing mix would mean going with a high liquidity plan for assets with short term financing. As oppose to aggressive approach, this approach implies easing into investment in heavy capital investment by keeping a high liquidity profile. Therefore, this strategy can earn a return of 13% and financing cost being 10% for short term financing.

Therefore, net return with this strategy = Return of 13% minus Cost of 10% = 3%

Return = 850,000 * 3% = $ 25,500

(3) Computation of anticipated return after financing costs with the two moderate approaches to the asset-financing mix:

Moderate approaches implies opting for both aggressive and conservative approach in order to be aggressive with enough prudence on the hindsight. Therefore, this strategy would mean having a equal weight distribution of both aggressive as well as conservative approach.

Net return with moderate approach = (0.5*16% + 0.5*13%) minus (0.5*12% + 0.5*10%) = 3.5%

Return = 850,000 * 3.5% = $ 29,750