Barnes Company has highly seasonal sales and financing requirements. Barnes has made the following projections of its asset needs and net additions to retained earnings over the next year (in $ million). $\begin{array}{llll}& \text { Fixed } & \text { Current } & \text { Net Additions } \
\text { Quarter } & \text { Assets } & \text { Assets } & \text { to Retained Earnings }\
\hline 1 & \$ 60 & \$ 30 & \$ 1 \
2 & \$ 60 & \$ 35 & \$ 2 \
3 & \$ 65 & \$ 40 & \$ 4 \
4 & \$ 65 & \$ 35 & \$ 2
\end{array}$ ? Net worth (equity) at the beginning of the year is $50 million. The company does not plan to sell any new equity during the coming year. Assume Barnes follows a matching approach to finance its assets (i.e., long-term debt and equity are used to finance fixed and permanent current assets and short-term debt is used to finance fluctuating current assets). Determine the amount of long-term and short-term debt, respectively, outstanding at the end of the third quarter ($ million).

Question

Quizplus · Accepted Answer

The matching approach to financing means that long-term debt and equity are used to finance fixed assets and permanent current assets, while short-term debt is used to finance fluctuating current assets. At the end of the third quarter, the fixed assets are $65 million, and the highest level of current assets is $40 million, indicating the permanent current asset level. The net additions to retained earnings by the end of the third quarter are $1 million + $2 million + $4 million = $7 million. Therefore, the total financing needed for fixed and permanent current assets is $65 million (fixed) + $40 million (permanent current) = $105 million. The equity at the beginning of the year is $50 million, and the net additions to retained earnings add another $7 million, making total equity $57 million. Thus, the long-term debt needed is $105 million (total financing needed) - $57 million (equity) = $48 million. The fluctuating current assets at the end of the third quarter are $0, as the current assets are at their peak (permanent level), meaning no additional short-term debt is needed for fluctuating current assets.

Barnes Company Has Highly Seasonal Sales and Financing Requirements ? Net Worth (Equity) at the Beginning of the Year