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Lear Inc. has \(840,000 in current assets, \)370,000 of which are considered permanent current assets. In addition, the firm has \(640,000 invested in fixed assets.

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 and the balance with short-term financing. The same interest rates apply as in part a. Earnings before interest and taxes will be \)240,000. What will be Lear’s earnings after taxes? The tax rate is 30 percent.

Short Answer

Expert verified

The earnings after tax will be $86,765 in the alternative plan.

Step by step solution

01

Information given in the question

The following information is provided:

Temporary current assets =$470,000

Permanent current assets =$370,000

Fixed assets =$640,000

Total assets =$1,480,000

Tax rate = 30%

02

 Calculation of interest expense in the alternative financing plan

The interest expense will be $116,050.

Longteminterestexpense=Assetstobefinanced×Interestrate=($640,000+$370,000+12×$470,000)×8%=$1,245,000×8%=$99,600

Shortterminterestexpense=Assetstobefinanced×Interestrate=($470,000×12)×7%=$235,000×7%=$16,450

03

Calculation of earnings after tax

The earnings after tax will be $86,765.

Earningaftertaxes=Earningbeforeinterestandtaxes-Interestexpense-Taxes=$240,000-$116,050-$37,185=$86,765

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Most popular questions from this chapter

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.

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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.

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Lear Inc. has \(840,000 in current assets, \)370,000 of which are considered permanent current assets. In addition, the firm has \(640,000 invested in fixed assets.

a. Lear wishes to finance all fixed assets and half of its permanent current assets with long-term financing costing 8 percent. The balance will be financed with short-term financing, which currently costs 7 percent. Lear’s earnings before interest and taxes are \)240,000. Determine Lear’s earnings after taxes under this financing plan. The tax rate is 30 percent.

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 and the balance with short-term financing. The same interest rates apply as in part a. Earnings before interest and taxes will be $240,000. What will be Lear’s earnings after taxes? The tax rate is 30 percent.

c. What are some of the risks and cost considerations associated with each of these alternative financing strategies?

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