December 9, 2010
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.
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
Earnings before taxes
Earnings after taxes
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=...
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