Question

Aggressive versus conservative seasonal funding strategy Dynabase Tool has forecast its total funds requirements for the coming year as shown in the following table.

Month	Amount	Month	Amount
January	$2,000,000	July	$12,000,000
February	2,000,000	August	14,000,000
March	2,000,000	September	9,000,000
April	4,000,000	October	5,000,000
May	6,000,000	November	4,000,000
June	9,000,000	December	3,000,000

1. Divide the firm’s monthly funds requirement into (1) a permanent component and (2) a seasonal component, and find the monthly average for each of these components.

2. Describe the amount of long-term and short-term financing used to meet the total funds requirement under (1) an aggressive funding strategy and (2) a conservative funding strategy. Assume that, under the aggressive strategy, long-term funds finance permanent needs and short-term funds are used to finance seasonal needs.

3. Assuming that short-term funds cost 5% annually and that the cost of long-term funds is 10% annually, use the averages found in part a to calculate the total cost of each of the strategies described in part b. Assume that the firm can earn 3% on any excess cash balances.

4. Discuss the profitability–risk tradeoffs associated with the aggressive strategy and those associated with the conservative strategy.

Answer 1

a. Average Permanent Component = $2000000

Average Seasonal Component = Total Seasonal Requirement / 12 = $48000000/12 = $4000000

b. Aggressive funding strategy, the company will borrow permanent requirement at long term rate and seasonal requirement of $1000000 to $12000000 on short term rate

conservative funding strategy the would borrow the peak level of total funds requirement at long term rate

c. Aggressive = Permanent Requirement * 10% + Average Seasonal requirement * 5%

Aggressive = 2000000 * 10% + 4000000 * 5%

Aggressive Strategy = $400000

Conservative Strategy = Peak Level * 10% = $14000000 * 10% = $1400000

d. Aggressive strategy looks more attractive when compared with conservative strategy on financing costs. as the aggressive strategy saves a lot in terms of finance costs but it will be associated with higher risks.

Aggressive - High Risk - High Cost Saving

Conservative - Low Risk - Low Cost saving