Q#1:Al Fateh Inc., has a seasonal pattern to its business. It borrows under a line of credit from Central Bank at 1% over prime. Its total asset requirements now (at year end) and estimated requirements for the coming year are (in millions):
Now
1st Qtr
2nd Qtr
3rd Qtr
4th Qtr
Total Asset Requirement
6.5
6.8
7.5
7.9
8
Assume that these requirements are level throughout the quarter. At present the company has $4.5 million in equity capital plus long-term debt plus the permanent component of current liabilities, and this amount will remain constant throughout the year. The prime rate currently is 15%, and the company expects no change in this rate for the next year. Mendez Metal Specialties is also considering issuing intermediate-term debt at an interest rate of 18.5 percent. In this regard, three alternative amounts are under consideration: zero, $1.5million, and $1.8 million. All additional funds requirements will be borrowed under the company’s bank line of credit.
Required: Determine the total dollar borrowing costs for short- and intermediate-term debt under each of the three alternatives for the coming year. (Assume that there are no changes in current liabilities other than borrowings.) Which alternative is lowest in cost? (10)
Answers
Answer:
Explanation:
Al Fateh Inc., has a seasonal pattern to its business. It borrows under a line of credit from Central Bank at 1% over prime. Its total asset requirements now (at year end) and estimated requirements for the coming year are (in millions):
Now 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
Total Asset Requirement 6.5 6.8 7.5 7.9 8
Assume that these requirements are level throughout the quarter. At present the company has $4.5 million in equity capital plus long-term debt plus the permanent component of current liabilities, and this amount will remain constant throughout the year. The prime rate currently is 15%, and the company expects no change in this rate for the next year. Mendez Metal Specialties is also considering issuing intermediate-term debt at an interest rate of 18.5 percent. In this regard, three alternative amounts are under consideration: zero, $1.5million, and $1.8 million. All additional funds requirements will be borrowed under the company’s bank line of credit.
Required: Determine the total dollar borrowing costs for short- and intermediate-term debt under each of the three alternatives for the coming year. (Assume that there are no changes in current liabilities other than borrowings.) Which alternative is lowest in cost?