Table 15.1
Irish Air Services has determined several factors relative to its asset and financing mix.
(a) The firm earns 10 percent annually on its current assets.
(b) The firm earns 20 percent annually on its fixed assets.
(c) The firm pays 13 percent annually on current liabilities.
(d) The firm pays 17 percent annually on long-term funds.
(e) The firm's monthly current, fixed, and total asset requirements for the previous year are summarized in the table below:
-The firm's annual financing costs of conservative financing strategy are ________. (See Table 15.1)
A) $22,775
B) $26,075
C) $26,775
D) $21,175

Question

Table 15.1
Irish Air Services has determined several factors relative to its asset and financing mix.
(a) The firm earns 10 percent annually on its current assets.
(b) The firm earns 20 percent annually on its fixed assets.
(c) The firm pays 13 percent annually on current liabilities.
(d) The firm pays 17 percent annually on long-term funds.
(e) The firm's monthly current, fixed, and total asset requirements for the previous year are summarized in the table below: 
-The firm's annual financing costs of conservative financing strategy are ________. (See Table 15.1)
A) $22,775 
B) $26,075 
C) $26,775 
D) $21,175

Quizplus · Accepted Answer

To calculate the firm's annual financing costs, we need to determine the total amount of current liabilities and long-term funds needed to finance the total asset requirements, and then multiply those amounts by the respective financing costs.

From the table, we can see that the monthly current asset requirement is $60, and the monthly fixed asset requirement is $240. Therefore, the monthly total asset requirement is $300. Multiplying this by 12, we get the firm's total asset requirement for the year, which is $3,600.

To determine the financing mix, we can subtract the firm's current assets from its total asset requirement to get its fixed assets, as follows:

Fixed assets = Total assets - Current assets
Fixed assets = $3,600 - ($60 x 12)
Fixed assets = $3,600 - $720
Fixed assets = $2,880

Next, we need to determine the amount of current liabilities and long-term funds needed to finance these assets. Using the conservative financing strategy, we would finance all of the firm's current assets with short-term financing (i.e., current liabilities), and 70% of its fixed assets with long-term financing. Therefore:

Current liabilities = Current assets = $60 x 12 = $720
Long-term funds = 70% of fixed assets = 0.7 x $2,880 = $2,016

Now we can calculate the firm's annual financing costs:

Current liabilities financing cost = $720 x 13% = $93.60
Long-term funds financing cost = $2,016 x 17% = $342.72

Total financing cost = Current liabilities financing cost + Long-term funds financing cost
Total financing cost = $93.60 + $342.72
Total financing cost = $436.32

However, we also need to consider the returns earned on the firm's assets, which will partially offset these financing costs. From the problem statement, we know that the firm earns 10% annually on its current assets, and 20% annually on its fixed assets. Therefore, we can calculate the firm's total return on assets as follows:

Total return on assets = (Current assets x 10%) + (Fixed assets x 20%)
Total return on assets = ($60 x 12 x 10%) + ($2,880 x 20%)
Total return on assets = $72 + $576
Total return on assets = $648

Finally, we can calculate the net financing cost (i.e., financing costs minus returns earned on assets) as follows:

Net financing cost = Total financing cost - Total return on assets
Net financing cost = $436.32 - $648
Net financing cost = -$211.68

Since the net financing cost is negative, this implies that the firm is earning a higher return on its assets than it is paying in financing costs. Therefore, the best choice is not to pursue a conservative financing strategy, but instead to explore more aggressive financing options.

Table 15.1 Irish Air Services Has Determined Several Factors Relative to Its