Question

Aggressive versus conservative seasonal funding strategy Dynabase Tool has forecast its total funding requirements for the coming year as shown in the following table: FF a. Divide the firm's monthly funding requirement into (1) a permanent component and (2) a seasonal component, and find the monthly average for each of these components b. Describe the amount of long-term and short-term financing used to meet the total funds requirement under (1) an aggressive funding strategy and (2) a conservative funding strategy. Assume that under the aggressive strategy, long-term funds finance permanent needs and short-term funds are used to finance seasonal needs. c. Assuming that short-term funding costs 5% annually and that the cost of long-term funding is 10% annually use the averages found in part a to calculate the total cost of each of the strategies described in part b. Assume that the firm can earn 3% on any excess cash balances. d. Discuss the profitability-risk trade-offs associated with the aggressive strategy and those associated with the conservative strategy a. Divide the firm's monthly funding requirement into (1) a permanent component and (2) a seasonal component, and find the monthly average for each of these components The monthly average of the firm's permanent funding requirement is $ 1(Round to the nearest dollar) The monthly average of the firm's seasonal funding requirement is $ I. (Round to the nearest dollar) b. Describe the amount of long-term and short-term financing used to meet the total funds requirement under (1) an aggressive funding strategy and (2) a conservative funding strategy

Answer 1

Minium requirement Formula in all months Т-P Total fund Seasonal Permanent requirement (P) requirement (S) Month requirement (T) 2000000 2000000 January 2000000 2000000 February 0 March 2000000 2000000 April May 3000000 2000000 1000000 6000000 2000000 4000000 June 8000000 2000000 6000000 July 13000000 2000000 11000000 August 15000000 2000000 13000000 2000000 2000000 2000000 2000000 24000000 September 12000000 10000000 7000000 3000000 4000000 77000000 October 5000000 November December 1000000 2000000 Total sum (TS) 53000000 Average (A TS/12) 2000000 4416667

a). Monthly average of permanent funding requirement = 2,000,000

Monthly average of seasonal funding requirement = 4,416,667

b). With aggressive funding, it will fund seasonal needs with short-term funding so amount will be 4,416,667

With aggressive funding, it will fund permanent needs with long-term funding so amount will be 2,000,000

With a conservative funding strategy, it will fund the peak requirement of 15,000,000 with long-term debt.

c). Aggressive strategy cost of funds = (long-term cost*permanent average funding) + (short-term cost*seasonal average funding) = (10%*2,000,000) + (5%*4,416,667) = 420,833

Conservative strategy cost of funds = (long-term cost*peak requirement) - (peak requirement - permanent average - seasonal average)*interest earned on excess cash balances

= (10%*15,000,000) - (15,000,000 - 2,000,000 - 4,416,667)*3% =1,242,500

d). Option B is false. The conservative strategy is not more attractive here as it costs more than the aggressive strategy.