Question

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

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

Step-by-step solution

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%

 Calculation of interest expense in the alternative financing plan

The interest expense will be $116,050.

$\begin{array}{rcl}\mathit{L}\mathit{o}\mathit{n}\mathit{g}\mathbf{}\mathit{t}\mathit{e}\mathit{m}\mathbf{}\mathit{i}\mathit{n}\mathit{t}\mathit{e}\mathit{r}\mathit{e}\mathit{s}\mathit{t}\mathbf{}\mathit{e}\mathit{x}\mathit{p}\mathit{e}\mathit{n}\mathit{s}\mathit{e}& \mathbf{=}& \mathit{A}\mathit{s}\mathit{s}\mathit{e}\mathit{t}\mathit{s}\mathbf{}\mathit{t}\mathit{o}\mathbf{}\mathit{b}\mathit{e}\mathbf{}\mathit{f}\mathit{i}\mathit{n}\mathit{a}\mathit{n}\mathit{c}\mathit{e}\mathit{d}\mathbf{\times }\mathit{I}\mathit{n}\mathit{t}\mathit{e}\mathit{r}\mathit{e}\mathit{s}\mathit{t}\mathbf{}\mathit{r}\mathit{a}\mathit{t}\mathit{e}\\ & \mathbf{=}& \left(\$640,000+\$370,000+\frac{1}{2}\times \$470,000\right)\mathbf{\times }\mathbf{8}\mathbf{\%}\\ & \mathbf{=}& \mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{245}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{8}\mathbf{\%}\\ & \mathbf{=}& \mathbf{\$}\mathbf{99}\mathbf{,}\mathbf{600}\end{array}$

$\begin{array}{rcl}\mathit{S}\mathit{h}\mathit{o}\mathit{r}\mathit{t}\mathbf{}\mathit{t}\mathit{e}\mathit{r}\mathit{m}\mathbf{}\mathit{i}\mathit{n}\mathit{t}\mathit{e}\mathit{r}\mathit{e}\mathit{s}\mathit{t}\mathbf{}\mathit{e}\mathit{x}\mathit{p}\mathit{e}\mathit{n}\mathit{s}\mathit{e}& \mathbf{=}& \mathit{A}\mathit{s}\mathit{s}\mathit{e}\mathit{t}\mathit{s}\mathbf{}\mathit{t}\mathit{o}\mathbf{}\mathit{b}\mathit{e}\mathbf{}\mathit{f}\mathit{i}\mathit{n}\mathit{a}\mathit{n}\mathit{c}\mathit{e}\mathit{d}\mathbf{\times }\mathit{I}\mathit{n}\mathit{t}\mathit{e}\mathit{r}\mathit{e}\mathit{s}\mathit{t}\mathbf{}\mathit{r}\mathit{a}\mathit{t}\mathit{e}\\ & \mathbf{=}& \left(\$470,000\times \frac{1}{2}\right)\mathbf{\times }\mathbf{7}\mathbf{\%}\\ & \mathbf{=}& \mathbf{\$}\mathbf{235}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{7}\mathbf{\%}\\ & \mathbf{=}& \mathbf{\$}\mathbf{16}\mathbf{,}\mathbf{450}\end{array}$

Calculation of earnings after tax

The earnings after tax will be $86,765.

$\begin{array}{rcl}\mathit{E}\mathit{a}\mathit{r}\mathit{n}\mathit{i}\mathit{n}\mathit{g}\mathbf{}\mathit{a}\mathit{f}\mathit{t}\mathit{e}\mathit{r}\mathbf{}\mathit{t}\mathit{a}\mathit{x}\mathit{e}\mathit{s}& \mathbf{=}& \mathit{E}\mathit{a}\mathit{r}\mathit{n}\mathit{i}\mathit{n}\mathit{g}\mathbf{}\mathit{b}\mathit{e}\mathit{f}\mathit{o}\mathit{r}\mathit{e}\mathbf{}\mathit{i}\mathit{n}\mathit{t}\mathit{e}\mathit{r}\mathit{e}\mathit{s}\mathit{t}\mathbf{}\mathit{a}\mathit{n}\mathit{d}\mathbf{}\mathit{t}\mathit{a}\mathit{x}\mathit{e}\mathit{s}\mathbf{-}\mathit{I}\mathit{n}\mathit{t}\mathit{e}\mathit{r}\mathit{e}\mathit{s}\mathit{t}\mathbf{}\mathit{e}\mathit{x}\mathit{p}\mathit{e}\mathit{n}\mathit{s}\mathit{e}\mathbf{-}\mathit{T}\mathit{a}\mathit{x}\mathit{e}\mathit{s}\\ & \mathbf{=}& \mathbf{\$}\mathbf{240}\mathbf{,}\mathbf{000}\mathbf{-}\mathbf{\$}\mathbf{116}\mathbf{,}\mathbf{050}\mathbf{-}\mathbf{\$}\mathbf{37}\mathbf{,}\mathbf{185}\\ & \mathbf{=}& \mathbf{\$}\mathbf{86}\mathbf{,}\mathbf{765}\end{array}$