Question

Assume that Hogan Surgical Instruments Co. has $2,100,000 in assets. If it goes with a low-liquidity plan for the assets, it can earn a return of 14 percent, but with a high-liquidity plan, the return will be 10 percent. If the firm goes with a short-term financing plan, the financing costs on the $2,100,000 will be 6 percent, and with a long-term financing plan, the financing costs on the $2,100,000 will be 8 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.

Answer 1

a.

Most aggressive

Low liquidity = $2,100,000 × 14% =$294,000

Short-term financing = $2,100,000 × 6% = 126,000

Anticipated return$ = 294,000 - 126,000

                                     = 168,000

b.

Most conservative

High liquidity = $2,100,000 × 10% =$ 210,000

Long-term financing = $2,100,000 × 8% = 168,000

Anticipated return= 210,000 - 168,000

                                  = 42,000

c.

Moderate approach

Low liquidity = 2,100,000 × 14% =$294,000

Long-term financing = $2,100,000 × 8% = 168,000

Anticipated return= 294,000 - 168,000

                                  = 126,000

OR

High liquidity = $2,100,000 × 10% =$ 210,000

Short-term financing = $2,100,000 × 6% = 126,000

Anticipated return= 210,000 - 126,000

                                  = 84,000