Question

Case study: Financing policies

AAA, Inc, a manufacturer, hired you as a financial analysist. You verified AAA financial documents and you encountered the following information.

To: Julian Jones, CEO From: A. Banks, Controller Date: February 1, 20X4 Subject: Financing options Hi Ms. Jones, Following our previous correspondence about the financing options for our new project. My team has determined several possible levels of working capital that involve fundamental decisions regarding our firm’s liquidity and the maturity composition of dent portfolio. I have listed the three financing options below. Each option has advantages and disadvantages. I will discuss further details at our next meeting. Option 1: $75 million equity and long-term debt against long-term assets, permanent working capital, and temporary working capital; $5 million short-term overdrafts and bank loans against temporary working capital. Option 2: $55 million equity and long-term debt against long-term assets and permanent working capital; $30 million short-term overdrafts and bank loans against temporary working capital and temporary working capital. Option 3: $65 million equity and long-term debt against long-term assets and permanent working capital; $15 million short-term overdrafts and bank loans against temporary working capital. For your reference, I have attached a summary of our firm’s working structure for the most recent 3 years. Please let me know if you have any questions. Regards, Julian Jones

AAA Inc. Summary of Working Capital (WC) Structure Year WC-Slack Season (million) WC-Slack Season (million) 2XX1 $55 $65 2XX2 $55 $72 2XX3 $55 $70 Prepared by JJ.

To: Amanda Banks, Controller From: R. Blake, Accounting Manager Date: February 1, 2XX4 Subject: Financing options Hi Amanda, As your requested, below are the current outstanding amounts of our capital funds. Sources of funds Dollar amount (in millions) Mortgage bonds, $1000 par, 7.5%, due 2X30 $105 Debentures, $1000 par, 8%, due 2X29 215 Preferred stock, $100 par, 7.5% 90 Commercial loan, due in 11 months 10 Common stock, $10 par 100 Commercial paper 25 Retained earnings 325 Let me know if you need more information, RB

Using the information provided above, answer the following questions.

1. Classify the options in the Controller e-mail as conservative policy, moderate policy, or aggressive policy.
2. Determine the appropriate amount of capital in 20X4 corresponding to
   1. Temporary working capital for 20X4
   2. Permanente working capital for 20X4
3. From the e-mail of R Blake, determine the type of financing (Long-term financing, short-term financing, or spontaneous financing) for each source of funds.

Answer 1

To solve this question just input those variables which are to be used in logistic regression, as the question talks about using two variables only that is total loans and leases to total assets & total expenses/ total assets, so we will not input total cap/assets as an input variable in our excel, here we go

As one can see, we have taken only two variables , total exp/assets and total lns & leases/ assets in calculation, follwing steps have been followed to construct the above table

1. Assume logit= b0+ b1* independent variable1+ b2* independent variable 2 , take values of b0=0.1, b1=0.1, b2=0.1, note that these values of b0, b1 and b2 are just taken for calculation, one could assume any values here for bo , b1 and b2

2. Calculate exponential of logit in the next column by using exp (value in previous column)

3. Calculate probability by using formula, probability= exp (logit)/ { 1+ exp(logit)} in the next column

4. In next column, calculate log likelihood by using formula : financial condition value (i.e. 1 or 0) * LN( probability calculated in previous column) + (1- financial condition value)* LN( 1- probability calculated in previous column)

5. take the total of the column values of log likelihood

6. use solver function in excel to change this total by putting max value of 0 and changing the variable cells containing assumed values of b0, b1 and b2 , by clicking on solve, you will get actual values of b0, b1 and b2

which comes out to be b0=-14.72, b1=89.83, b2= 8.37

therefore you will get logit as

-14.72+ 89.83* Total exp/assets+8.37*Total lns & lsses/ assets

With values given in the question as total exp/ assets= 0.11 and total loans & leases/ assets= 0.6 , we get

logit as -14.72+ 89.83* 0.11+ 8.37*0.6= 0.1833

exp (logit) = 1.20

Probability= 0.546

Loglikelihood= 1*LN(0.546)+0*LN(1-0.546)= LN(0.546)= -0.605