Chapter 6, Problem 11P

Assume that Atlas Sporting Goods Inc. has $\text{\$840,000}$ in assets. If it goes with a low-liquidity plan for the assets, it can earn a return of 15 percent, but with a high-liquidity plan the return will be 12 percent. If the firm goes with a short-term financing plan, the financing costs on the $\text{\$840,000}$ will be 9 percent, and with a long-term financing plan, the financing costs on the $\text{\$840,000}$ will be 11 percent. (Review Table 6-11 for parts a, b, and c of this problem.)

a. Compute the anticipated return after financing costs with the most aggressive asset financing mix.

b. Compute the anticipated return after financing costs with the most conservative asset financing mix.

c. Compute the anticipated return after financing costs with the two moderate approaches to the asset financing mix.

d. If the firm used the most aggressive asset financing mix described in part a and had the anticipated return you computed for part a, what would earnings per share be if the tax rate on the anticipated return was 30 percent and there were 20,000 shares outstanding?

e. Now assume the most conservative asset financing mix described in part b will be utilized. The tax rate will be 30 percent. Also assume there will only be 5,000 shares outstanding. What will earnings per share be? Would it be higher or lower than the earnings per share computed for the most aggressive plan computed in part d?

Summary Introduction

To calculate: The anticipated return, after deducting the finance costs, with the most aggressive approach of the asset financing mix.

Introduction:

Anticipated return:

It is the amount that an individual or company has estimated to earn from an investment. It is one of the factors taken into account by an investor before selecting an investment plan.

Aggressive approach:

When a company selects a plan of low liquidity with high return and long-term financing, it is termed as an aggressive approach.

Answer to Problem 11P

The anticipated return, after deducting the finance costs, with the most aggressive approach of the asset financing mix is $50,400.

Explanation of Solution

The calculation of the anticipated return is as follows.

$\begin{array}{c}\text{Anticipated Return}=\text{Return from Low-Liquidity Plan}-\text{Finance Cost of Short-Term Finance}\\ =\$126,000-\$75,600\\ =\$50,400\end{array}$

Working notes:

The calculation of the return from the low liquidity plan is as follows.

$\begin{array}{c}\text{Return}=\text{Assets Cost}\times \text{Rate of Return}\\ =\$840,000\times 15\%\\ =\$126,000\end{array}$

The calculation of the finance cost of short-term financing is as follows.

$\begin{array}{c}\text{Finance Cost}=\text{Assets Cost}\times \text{Interest Rate}\\ =\$840,000\times 9\%\\ =\$75,600\end{array}$

Summary Introduction

To calculate: The anticipated return, after deducting the finance costs, with the most conservative approach of the asset financing mix.

Introduction:

Conservative approach:

When a company selects a plan of high liquidity with low return and short-term financing, it is termed as a conservative approach.

Answer to Problem 11P

The anticipated return, after deducting the finance costs, with the most conservative approach of the asset financing mix is $8,400.

Explanation of Solution

The calculation of the anticipated return is as follows.

$\begin{array}{c}\text{Anticipated Return}=\text{Return from High-Liquidity Plan}-\text{Finance Cost of Long-Term Finance}\\ =\$100,800-\$92,400\\ =\$8,400\end{array}$

Working notes:

The calculation of the return from the high liquidity plan is as follows.

$\begin{array}{c}\text{Return}=\text{Assets Cost}\times \text{Rate of Return}\\ =\$840,000\times 12\%\\ =\$100,800\end{array}$

The calculation of the finance cost of long-term financing is as follows.

$\begin{array}{c}\text{Finance Cost}=\text{Assets Cost}\times \text{Interest Rate}\\ =\$840,000\times 11\%\\ =\$92,400\end{array}$

Summary Introduction

To calculate: The anticipated return, after deducting the finance costs, with the two moderate approaches of the asset financing mix.

Introduction:

Moderate approach:

When a company selects a plan of low liquidity with high return and short-term financing or one of high liquidity with low return and long-term financing, it is termed as a moderate approach.

Answer to Problem 11P

The anticipated return, after deducting the finance costs, with the moderate approach of the low liquidity plan and long-term financing of the asset financing mix is $33,600.

The anticipated return, after deducting the finance costs, with the moderate approach of the high liquidity plan and short-term financing of the asset financing mix is $25,200.

Explanation of Solution

Anticipated return in the moderate approach of the low liquidity plan and long-term financing of the asset financing mix:

The calculation of the anticipated return is as follows.

$\begin{array}{c}\text{Anticipated Return}=\text{Return from Low-Liquidity Plan}-\text{Finance Cost of Long-Term Finance}\\ =\$126,000-\$92,400\\ =\$33,600\end{array}$

Working notes:

The calculation of the return from the low liquidity plan is as follows.

$\begin{array}{c}\text{Return}=\text{Assets Cost}\times \text{Rate of Return}\\ =\$840,000\times 15\%\\ =\$126,000\end{array}$

The calculation of the finance costs of long-term financing is as follows.

$\begin{array}{c}\text{Finance Cost}=\text{Assets Cost}\times \text{Interest Rate}\\ =\$840,000\times 11\%\\ =\$92,400\end{array}$

Anticipated return in the moderate approach of the high liquidity plan and short-term financing of the asset financing mix:

The calculation of the anticipated return is as follows.

$\begin{array}{c}\text{Anticipated Return}=\text{Return from High-Liquidity Plan}-\text{Finance Cost of Short-Term Finance}\\ =\$100,800-\$75,600\\ =\$25,200\end{array}$

Working notes:

The calculation of the return from the high-liquidity plan is as follows.

$\begin{array}{c}\text{Return}=\text{Assets Cost}\times \text{Rate of Return}\\ =\$840,000\times 12\%\\ =\$100,800\end{array}$

The calculation of the finance costs of short-term financing is as follows.

$\begin{array}{c}\text{Finance Cost}=\text{Assets Cost}\times \text{Interest Rate}\\ =\$840,000\times 9\%\\ =\$75,600\end{array}$

Summary Introduction

To calculate: The earnings per share if Atlas Sporting Goods Inc. uses the aggressive approach of the asset financing mix with the anticipated return computed in part (a).

Introduction:

Earnings per share:

It is a measurement of the company's profitability. It is calculated by dividing the net income less dividend paid for the prefernece stock by the average number of outstanding shares.

Answer to Problem 11P

The calculation of the earnings per share is as follows.

If Atlas Sporting Goods Inc. uses the aggressive approach of the asset financing mix with the anticipated return computed in part (a), its earnings per share is $1.76.

Explanation of Solution

The calculation of the earnings per share using Excel is as follows.

Summary Introduction

To calculate: The earnings per share if Atlas Sporting Goods Inc. uses the conservative approach of the asset financing mix with the anticipated return computed in part (b) as well as to check whether it is higher or lower than the earnings per share computed in part (d).

Introduction:

Earnings per share:

It is a measurement of the company's profitability. It is calculated by dividing the net income less dividend paid for the preference stock by the average number of outstanding shares.

Answer to Problem 11P

The calculation of the earnings per share is as follows.

If Atlas Sporting Goods Inc. uses the conservative approach of the asset financing mix with the anticipated return computed in part (b), its earnings per share is $1.18.

The earnings per share by the conservative approach of the asset financing mix, that is, $1.18 is lower that by the aggressive approach of the asset financing mix, that is, $1.97.

Explanation of Solution

The formula used for the calculation of the earnings per share using Excel is as follows.