Question

Assume that Atlas Sporting Goods Inc. has $880,000 in assets. If it goes with a low-liquidity plan for the assets, it can earn a return of 12 percent, but with a high-liquidity plan the return will be 9 percent. If the firm goes with a short-term financing plan, the financing costs on the $880,000 will be 6 percent, and with a long-term financing plan the financing costs on the $880,000 will be 7 percent. a. Compute the anticipated return after financing costs with the most aggressive asset-financing mix. Anticipated return b. Compute the anticipated return after financing costs with the most conservative asset-financing mix. Anticipated return c. Compute the anticipated return after financing costs with the two moderate approaches to the asset-financing mix. Anticipated Return Low liquidity High liquidity

Answer 1

a) Most Aggressive asset financing mix is when we choose low liquidity plan for assets and short term financing plan.

So, in this case, we calculate anticipated return as follows:-

Anticipated Return = (Return on Assets invested - Financing cost) / Value of Asset

    = [(Asset Value * Return on Low liquidity plan) - (Finance amount * Short term financing cost)] / Value of Asset

= [($ 880,000 * 12%) - ($ 880,000 * 6%)] / $ 880,000

= $ 52,800 / $ 880,000

= 6 %

b) Most Conservative asset financing mix is when we choose High liquidity plan for assets and Long term financing plan.

So, in this case, we calculate anticipated return as follows:-

Anticipated Return = (Return on Assets invested - Financing cost) / Value of Asset

    = [(Asset Value * Return on high liquidity plan) - (Finance amount * Long term financing cost)] / Value of Asset

= [($ 880,000 * 9%) - ($ 880,000 * 7%)] / $ 880,000

= $ 17,600 / $ 880,000

= 2 %

c) (i) Moderate asset financing mix will be Low liquidity Asset Plan and long term financing plan

So, in this case, we calculate anticipated return as follows:-

Anticipated Return = (Return on Assets invested - Financing cost) / Value of Asset

    = [(Asset Value * Return on Low liquidity plan) - (Finance amount * Long term financing cost)] / Value of Asset

= [($ 880,000 * 12%) - ($ 880,000 * 7%)] / $ 880,000

= $ 44,000 / $ 880,000

= 5 %

(ii) Moderate asset financing mix will be High liquidity Asset Plan and Short term financing plan

So, in this case, we calculate anticipated return as follows:-

Anticipated Return = (Return on Assets invested - Financing cost) / Value of Asset

    = [(Asset Value * Return on High liquidity plan) - (Finance amount * Short term financing cost)] / Value of Asset

= [($ 880,000 * 9%) - ($ 880,000 * 6%)] / $ 880,000

= $ 26,400 / $ 880,000

= 3 %

d) Return amount as per most aggressive asset financing mix = $ 52,800

Post tax Return amount will be $ 52,800 * (1-0.3) = $ 36,960

Now, Earnings per share = Post Tax Return / No of Shares

= $ 36,960 / 20,000 Shares

= $ 1.85