Can anyone help me to solve this question? Thanks

[omegazx]

IJM Berhad is trying to develop an asset- financing plan. The firm has $400,000 in temporary current asset and $300,000 in permanent current assets. IJM Berhad also has $500,000 in fixed assets. Assume a tax rate of 40 percent. Determine the interest charged for the two alternative financing plans for IJM Berhad.

One of the plans should be conservative, with 75% of assets financed by long term sources, and the other should be aggressive, with only 56.25% of assets financed by long- term sources. The current interest rate is 15% on long- term funds and 10% on short- term financing.

 

[mike99]

One would want to match the long-term and permanent current assets ($800 000, which is 75% of $1,200,000) with the long-term financing structure, and the short-term assets - more liquid working capital - with the short-term financing structure (the $400,000). Use these with the interest rates given.

In the more aggressive policy, management would end up financing part of their permanent and fixed asset make-up with short-term loans. Do you understand why this is aggressive? Essentially, this would result in a mismatch of cashflows, whereby the company dips into their short-term financing, e.g., bank overdraft, which is often more expensive and would result in generating cashflows that do not match the financing cost or the timing (think of financing a big machine over a number of years: the cashflows which it generates would result in an inflow over a number of years that would be expected to match its financing outflows).

Use the 56.25% of $1,200,000, finance your fixed with long-term, and the remainder you take off the permanent current assets (e.g., safety/buffer inventory levels).

Hope this helps.