You are deciding on an appropriate capital structure for a f

You are deciding on an appropriate capital structure for a firm with the following assets: Primary working capital (Cash, Receivables, Inventory) of $300 million, Property Plant & Equipment of $300 million and accounts payable of $100 million. Target debt/total capital is 50%. What is the most appropriate mix of financing?

Question 17 options:

Bank revolver debt $50 million, long-term debt $200 million, equity $250 million.

Bank revolver debt $200 million, long-term debt $50 million, equity $250 million.

Bank revolver debt $150 million, long-term debt $150 million, equity $300 million.

Bank revolver debt $ 50 million, long-term debt $250 million, equity $300 million

Solution

Option B should be the Answer.

The most appropriate financing policy is matching the terms of maturity of assets and liabilities. Short term or current assets should be financed with current liabilities, whereas fixed assets should be financed with equity and long term debt.

Now in our question,

Total Assets = $300 mil of WC assets + $300 mil of property plant and equity = $600 mil

Total Assets = Current Liabilities + Long term Liabilities + Total Equity

600 = 100 + Short term debt + Long term debt + Equity

Long term debt + Equity + Short term debt = 500 ---> This equation helps us elimiate Option C and D as they add up to $600.

Net Current Assets = Total Current Assets - Current Liabilities = $300 - $100 = $200 --> This should be financed with short term debt, which is bank revolver debt. Hence, $200 mil should be revolver debt.

Which is Option B. Hence our answer