Question: Recall that Carson Company has obtained substantial loans from finance companies and commercial banks. The interest rate on the loans is tied to market interest rates and is adjusted every six months. It has a credit line with a bank in case it suddenly needs to obtain funds for a temporary period. It previously purchased Treasury securities that it could sell if it experiences any liquidity problems.

If the economy continues to be strong, Carson may need to increase its production capacity by about 50 percent over the next few years to satisfy demand. It is concerned about a possible slowing of the economy because of potential Fed actions to reduce inflation. It needs funding to cover payments for supplies. It is also considering the issuance of stock or bonds to raise funds in the next year.

The prevailing commercial paper rate on paper issued by large publicly traded firms is lower than the rate Carson would pay when using a line of credit. Do you think that Carson could issue commercial paper at this prevailing market rate?

b. Should Carson obtain funds to cover payments for supplies by selling its holdings of Treasury securities or by using its credit line? Which alternative has a lower cost? Explain.