Question

Assume that Atlas Sporting Goods Inc. has \(840,000 in assets. If it goes with a low-liquidity plan for the assets, it can earn a return of 15 percent, but with a high-liquidity plan the return will be 12 percent. If the firm goes with a short-term financing plan, the financing costs on the \)840,000 will be 9 percent, and with a long-term financing plan, the financing costs on the $840,000 will be 11 percent. (Review Table 6-11 for parts a, b, and c of this problem.)

a. Compute the anticipated return after financing costs with the most aggressive asset financing mix.

b. Compute the anticipated return after financing costs with the most conservative asset financing mix.

c. Compute the anticipated return after financing costs with the two moderate approaches to the asset financing mix.

d. If the firm used the most aggressive asset financing mix described in part a and had the anticipated return you computed for part a, what would earnings per share be if the tax rate on the anticipated return was 30 percent and there were 20,000 shares outstanding?

e. Now assume the most conservative asset financing mix described in part b will be utilized. The tax rate will be 30 percent. Also assume there will only be 5,000 shares outstanding. What will earnings per share be? Would it be higher or lower than the earnings per share computed for the most aggressive plan computed in part d?

Short answer

The anticipated return when using an aggressive approach is $50,400, a conservative approach is $8,400, and a moderate approach is $33,600 or $25,200. The earnings per share are$1.76 in the aggressive approach and $1.18 in the conservative approach.

Step-by-step solution

Information given in the question

The following information is provided:

Borrowing required = $840,000

Return on asset in low liquidity plan = 15%

Return on asset in high liquidity plan = 12%

Interest rate when using short-term financing plan = 9%

Interest rate when using long-term financing plan = 11%

Explanation for requirement (a)

The anticipated returns are $50,400.

$$\begin{gathered} AnticipatedReturn=\left(Borrowedfunds\times Lowliquidityplan\right)- \\ \left(Borrowedfunds\times Shortterminterestrate\right) \\ =\left(\$840,000\times 15\%\right)-\left(\$840,000\times 9\%\right) \\ =\$126,000-\$75,600 \\ =\$50,400 \end{gathered}$$

Explanation for requirement (b)

The anticipated returns are $8,400.$$\begin{gathered} AnticipatedReturn=\left(Borrowedfunds\times Highliquidityplan\right)- \\ \left(Borrowedfunds\times Longterminterestrate\right) \\ =\left(\$840,000\times 12\%\right)-\left(\$840,000\times 11\%\right) \\ =\$100,800-\$92,400 \\ =\$8,400 \end{gathered}$$

Explanation for requirement (c)

The anticipated returns are $33,600 or $25,200.

There can be two approaches

$$\begin{gathered} AnticipatedReturn=\left(Borrowedfunds\times Lowliquidityplan\right)- \\ \left(Borrowedfunds\times Shortterminterestrate\right) \\ =\left(\$840,000\times 15\%\right)-\left(\$840,000\times 11\%\right) \\ =\$126,000-\$92,400 \\ =\$33,600 \end{gathered}$$

$$\begin{gathered} AnticipatedReturn=\left(Borrowedfunds\times Highliquidityplan\right)- \\ \left(Borrowedfunds\times Longterminterestrate\right) \\ =\left(\$840,000\times 12\%\right)-\left(\$840,000\times 9\%\right) \\ =\$100,800-\$75,200 \\ =\$25,600 \end{gathered}$$

Explanation for requirement (d)

The earnings per share are $1.76.

$$\begin{gathered} Earningsaftertaxes=AnticipatedReturn-Taxes \\ =\$8,400-\$2,520 \\ =\$5,880 \\ Earningspershare=\frac{Earningsaftertaxes}{Numberofshare} \\ =\frac{\$35,280}{20,000} \\ =\$1.76 \end{gathered}$$

Explanation for requirement (e)

The earnings per share are $1.18. So, the earnings per share will be lower than the earnings per share calculated under the most aggressive plan.$$\begin{gathered} Earningsaftertaxes=AnticipatedReturn-Taxes \\ =\$8,400-\$2,520 \\ =\$5,880 \\ Earningspershare=\frac{Earningsaftertaxes}{Numberofshare} \\ =\frac{\$5,880}{5,000} \\ =\$1.18 \end{gathered}$$