Question

Guardian Inc. is trying to develop an asset financing plan. The firm has \(400,000 in temporary current assets and \)300,000 in permanent current assets. Guardian also has \(500,000 in fixed assets. Assume a tax rate of 40 percent.

b. Given that Guardian’s earnings before interest and taxes are \)200,000, calculate earnings after taxes for each of your alternatives.

Short answer

The earnings after tax will be $21,000 in the conservative approach and $27,750 in the aggressive approach.

Step-by-step solution

Information given in the question

The following information is provided:

Temporary current assets =$400,000

Permanent current assets =$300,000

Fixed assets =$500,000

Total assets =$1,200,000

Tax rate = 40%

Calculation of earnings after taxes in the conservative approach

The earnings after taxes will be $21,000 in the conservative approach.

$\begin{array}{rcl}\mathit{E}\mathit{a}\mathit{r}\mathit{n}\mathit{i}\mathit{n}\mathit{g}\mathbf{}\mathit{a}\mathit{f}\mathit{t}\mathit{e}\mathit{r}\mathbf{}\mathit{t}\mathit{a}\mathit{x}\mathit{e}\mathit{s}& \mathbf{=}& \mathit{E}\mathit{a}\mathit{r}\mathit{n}\mathit{i}\mathit{n}\mathit{g}\mathit{s}\mathbf{}\mathit{b}\mathit{e}\mathit{f}\mathit{o}\mathit{r}\mathit{e}\mathbf{}\mathit{i}\mathit{n}\mathit{t}\mathit{e}\mathit{r}\mathit{e}\mathit{s}\mathit{t}\mathbf{}\mathit{a}\mathit{n}\mathit{d}\mathbf{}\mathit{t}\mathit{a}\mathit{x}\mathit{e}\mathit{s}\mathbf{-}\mathit{I}\mathit{n}\mathit{t}\mathit{e}\mathit{r}\mathit{e}\mathit{s}\mathit{t}\mathbf{}\mathit{E}\mathit{x}\mathit{p}\mathit{e}\mathit{n}\mathit{s}\mathit{e}\mathit{s}\mathbf{-}\mathit{T}\mathit{a}\mathit{x}\mathit{e}\mathit{s}\\ & \mathbf{=}& \mathbf{\$}\mathbf{200}\mathbf{,}\mathbf{000}\mathbf{-}\mathbf{\$}\mathbf{165}\mathbf{,}\mathbf{000}\mathbf{-}\mathbf{\$}\mathbf{14}\mathbf{,}\mathbf{000}\\ & \mathbf{=}& \mathbf{\$}\mathbf{21}\mathbf{,}\mathbf{000}\end{array}$

Calculation of earnings after taxes in the aggressive approach

The earnings after taxes will be $27,750 in the aggressive approach.

$\begin{array}{rcl}\mathit{E}\mathit{a}\mathit{r}\mathit{n}\mathit{i}\mathit{n}\mathit{g}\mathbf{}\mathit{a}\mathit{f}\mathit{t}\mathit{e}\mathit{r}\mathbf{}\mathit{t}\mathit{a}\mathit{x}\mathit{e}\mathit{s}& \mathbf{=}& \mathit{E}\mathit{a}\mathit{r}\mathit{n}\mathit{i}\mathit{n}\mathit{g}\mathbf{}\mathit{b}\mathit{e}\mathit{f}\mathit{o}\mathit{r}\mathit{e}\mathbf{}\mathit{i}\mathit{n}\mathit{t}\mathit{e}\mathit{r}\mathit{e}\mathit{s}\mathit{t}\mathbf{}\mathit{a}\mathit{n}\mathit{d}\mathbf{}\mathit{t}\mathit{a}\mathit{x}\mathit{e}\mathit{s}\mathbf{-}\mathit{I}\mathit{n}\mathit{t}\mathit{e}\mathit{r}\mathit{e}\mathit{s}\mathit{t}\mathbf{}\mathit{e}\mathit{x}\mathit{p}\mathit{e}\mathit{n}\mathit{s}\mathit{e}\mathit{s}\mathbf{-}\mathit{T}\mathit{a}\mathit{x}\mathit{e}\mathit{s}\\ & \mathbf{=}& \mathbf{\$}\mathbf{200}\mathbf{,}\mathbf{000}\mathbf{-}\mathbf{\$}\mathbf{153}\mathbf{,}\mathbf{750}\mathbf{-}\mathbf{\$}\mathbf{46}\mathbf{,}\mathbf{250}\\ & \mathbf{=}& \mathbf{\$}\mathbf{27}\mathbf{,}\mathbf{750}\end{array}$