Principles of Managerial Finance

CHAPTER 15 Current Liabilities Management 665

CHAPTER 15 CASE Selecting Kanton Company’s Financing Strategy

and Unsecured Short-Term Borrowing Arrangement

M

orton Mercado, the CFO of Kanton Company, carefully developed the

estimates of the firm’s total funds requirements for the coming year. These

are shown in the following table.

In addition, Morton expects short-term financing costs of about 10% and

long-term financing costs of about 14% during that period. He developed the

three possible financing strategies that follow:

Strategy 1—Aggressive:Finance seasonal needs with short-term funds and

permanent needs with long-term funds.

Strategy 2—Conservative:Finance an amount equal to the peak need with

long-term funds and use short-term funds only in an emergency.

Strategy 3—Tradeoff:Finance $3,000,000 with long-term funds and finance

the remaining funds requirements with short-term funds.

Using the data on the firm’s total funds requirements, Morton estimated the

average annual short-term and long-term financing requirements for each strat-

egy in the coming year, as shown in the following table.

To ensure that, along with spontaneous financing from accounts payable

and accruals, adequate short-term financing will be available, Morton plans to

establish an unsecured short-term borrowing arrangement with its local bank,

Average annual financing

Strategy 1 Strategy 2 Strategy 3

Type of financing (aggressive) (conservative) (tradeoff)

Short-term $2,500,000 $ 0 $1,666,667

Long-term 1,000,000 7,000,000 3,000,000

Month Total funds Month Total funds

January $1,000,000 July $6,000,000

February 1,000,000 August 5,000,000

March 2,000,000 September 5,000,000

April 3,000,000 October 4,000,000

May 5,000,000 November 2,000,000

June 7,000,000 December 1,000,000