Alternative Financing Plans
14. Lear, Inc. has $800,000 in current assets, $350,000 of which are considered permanent current assets. In addition, the firm has $600,000 invested in fixed assets.
a. Lear wishes to finance all fixed assets and half of its permanent current assets with long-term financing costing 10 percent. Short- term financing currently costs 5 percent. Lear’s earnings before interest and taxes are $200,000. Determine Lear’s earning after taxes under this financing plan. The tax rate is 30 percent. First, I have to find the interest expense on both short- and long- term loans. So, I subtract permanent assets from current assets to get temporary current assets which I use to figure out the short- term interest expense: $800,000- $350,000= $450,000.
Short- term interest expense= .05$450,000+ 12$350,000=00)- term interest expense= .05($450,000 + assets to get temporary current assets which I use to figure out the short- term in.05$450,000+$175,000=.05$625,000=$31,250
Long- term interest expense= .10$600,000+ 12$350,000=.10$600,000+$175,000= .10$775,000=$77,500 Then, I add the short- and long- term interest: $31,250 + $77,500= $108,750. Earnings before interest and taxes | $200,000|
Interest expenses| 108,750|
Earnings before taxes| 91,250|
Taxes (30%)| 27,375|
Earnings after taxes| $63,875|
b. As an alternative, Lear might wish to finance all fixed assets and permanent current assets plus half of its temporary current assets with long- term financing. The same interest rates apply as in part a. Earnings before interest and taxes will be $200,000. What will be Lear’s earnings after taxes? The tax rate is 30 percent. This one is similar to part a, so first I have to calculate the interest expense for short- and long- term loans for all assets. Short- term interest expense: .0512$450,000= .05$225,000=$11,250 Long-term interest expense: .10$600,00+$350,000+ 12$450,000=...