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Shaun Manzano
MBA 504
Dr. Ignatius
Assignment 3.4: Chapter 15 - Case Study, Kanton Company
The case of Kanton Company financing strategy and unsecured short-term borrowing
arrangement The case introduces 3 main strategies that are made available: Aggressive,
conservative and tradeoff; each having their own unique advantages. This case will afford the
opportunity for each of the strategies to be reviewed, so that the best strategy can be identified.

Section A:
Determine the total annual cost of each of the three possible financing strategies. The data was
made available within the case information.

Avg. Annual Financing
Type of Financing Strategy 1
(Aggressive)
Strategy 2
(Conservative)
Strategy 3
(Tradeoff)
Short-Term $2,500,000 $ 0.00 $1,666,667
Long-Term 1,000,000 $7,000,000 $3,000,000
Cost $390,000 $980,000 $536,667
Short-Term Financing costs = 10% Long-Term Financing costs = 14%
Aggressive Strategy
Required amount: $2,500,000 short term and $1,000,000 long term
Cost: (10% x $2,500,000) + (14% x $1,000,000) = $390,000
Conservative Strategy
Required amount: $7,000,000 long term and $0 short term
Cost: (14% x $7,000,000) = $980,000
Trade-off strategy
Monthly average: Permanent = $3,000,000
Seasonal = $1,166,667 (all seasonal requirements / 12)
Seasonal = $1,166,667 ($14,000,000/ 12)
Cost: (10% x $1,166,667) + (14% x $3,000,000) = $536,667

Section B:
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Assume that the firm expects its current assets to total $4 million throughout the year.
Current liabilities = Avg. short-term financing
The short-term figures were used here:
Type of Financing Strategy 1
(Aggressive)
Strategy 2
(Conservative)
Strategy 3
(Tradeoff)
Short-Term

$2,500,000 $ 0.00 $1,666,667
Strategy Computation Avg. Amt. of Net
Working Capital for ea.
Strategy
Aggressive $4,000,000 - $2,500,000 = $1,500,000 $1,500,000
Conservative $4,000,000 - $0 = $4,000,000 $4,000,000
Trade-off $4,000,000 - $1,166,667 = $2,833,333 $2,833,333


Section C:
Discuss the profitability risk trade off associated with each financing strategy. Which strategy
would you recommend to Morton Mercado for Kanton Company? Why?

Strategy Profitability Analysis
Aggressive With an avg. of $1,500,000 working capital this option compared to
the others is the worst performing strategy; the company will need the
ability to forecast their short term credits this is just not enough working
capital after everything is transacted.
Conservative With an avg. of $4,000,000 working capital will allow the company to
have the highest capital amongst the rest of the choices, but is not my
choice, due to the risks associated to excess capital or no capital. Cost
the most for the long term approach.
Trade-off With an avg. of $2,833,333 working capital is my choice, it is flexible,
and also allows the company to have the money available when needed.






Section D:
Find the effective annual rate under:

The Line of credit agreement:
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Amt. Borrowed: $600,000
Prime Rate: 7%
Interest Rate: 2.5%

=$600,000 * (7% + 2.5%)
= $600,000 * 9.5%
=$57,000

Interest/available amount
= $57,000/ ($600,000 * 80%)
= $57,000/ $480,000
= 11.88%

The Revolving credit agreement:
Amt. Borrowed: $600,000
Prime Rate: 7%
Interest Rate: 3.0%
Commitment Fee: 50%

=$600,000 * (7% + 3.0%)
=$600,000 * 10%
= $60,000

Commitment fee
=$400,000 * 50%
= $2,000

=$60,000 + $2,000
=$62,000
=$62,000/ $600,000 * 80%
=$62,000/ $480,000
= 12.92%


Section E:
If the firm does expect to borrow an average of $600,000, which borrowing arrangement would
you recommend to Kanton? Explain why?

If cost is the concern of the organization then I would choose the Line of credit option, this
option is a little cheaper than the revolving fund option. If flexibility with funding requirement
were the #1 priority, then I would choose the revolving option, the funds are more available to
the company than the line of credit option. With this option, there is a 1% of extra costs that are
tied to the decision. This would be presented to Kanton, the same ways as I just presented the
data above.

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Reference:

Gitman, L. J. (2009). Principles of managerial finance. Boston: Pearson/Prentice Hall.