Remember that managers should always be concerned with creating value. In financ
ID: 2744680 • Letter: R
Question
Remember that managers should always be concerned with creating value. In financing decisions, value is created when earnings or efficiencies are enhanced, or when financial risk is reduced. Value can also be created by increasing financial leverage. A firm with $100 million in assets needs to finance an additional $15 million of asset growth. It has enough debt capacity to cover the new funding needed, but that is all it could reasonably hope to afford. The firm's stock price is near record high. The current dividend policy calls for a payout of 10%, and the firm's most recent annual earnings were $10 million. The company expects to experience rapid growth during the next 5 years. The company's seasonal working capital needs, which will grow with increasing sales, should probably be financed with
A) equity.
B) retained earnings, even if dividends have to be curtailed.
C) long-term debt.
D) short-term debt.
Explanation / Answer
Purpose of financing = Seasonal Working Capital Requirement
The the purpose is is only Seasonal Working Capital should be financed with Short Term debt.
The reason is that, the need is seasonal, The cost of short term debt less than long term debt.
The issue of equity is not suitable since the requirement is seasonal
If retained earnings is used and curtail the dividend, it will effect the image of the company.
Based on the above, the company should financed with short term debt.
The Answer is " D "