©2012 McGraw-Hill Ryerson Limited 1 of 39 Learning Objectives 5.Explain financing of assets in terms of hedging. (LO5) 6.Describe the term structure of interest rates, explain the theories that suggest its shape, and identify how it may be of use to a financial manager. (LO6) 7.Identify risk and profitability in determining the financing plan for current assets. (LO7)

©2012 McGraw-Hill Ryerson Limited 2 of 39 The Financing Decision: An Example The Edwards Corporation needs to finance $500,000 of working capital (current assets). It has identified two alternative financing plans. Plan A, which they deem “risky” and a more conservative Plan B. LO7

©2012 McGraw-Hill Ryerson Limited 3 of 39 Table 6-7 Alternative financing plans LO7

©2012 McGraw-Hill Ryerson Limited 4 of 39 Table 6-8 Impact of financing plans on earnings LO7

©2012 McGraw-Hill Ryerson Limited 5 of 39 Table 6-9 Expected returns under different economic conditions LO7

©2012 McGraw-Hill Ryerson Limited 6 of 39 Table 6-10 Expected returns for high-risk firm LO7

©2012 McGraw-Hill Ryerson Limited 7 of 39 An Optimal Policy The combination of financing patterns (short-term versus long-term) and asset liquidity produces 4 possible working capital alternatives: 1.the aggressive firm borrows short term and maintains relatively low levels of liquidity 2.the more moderate firm compensates for short-term financing with highly liquid assets 3.the more moderate firm balances low liquidity with long- term Financing 4.the more conservative firm utilizes long-term financing and maintains a high degree of liquidity Each alternative represents a trade-off between risk and return. An appropriate strategy is selected based on the company’s tolerance for risk. LO7

©2012 McGraw-Hill Ryerson Limited 8 of 39 Table 6-11 Current asset liquidity and asset financing plan LO7