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.
a. 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 earnings after taxes under this financing plan.
The tax rate is 30 percent.
A. 175,000(half of working capital)+600,000(fixed assets)=775,000 in assets to be financed with LT Debt (10% interest rate)
The other $175,000(half of permanent current) will be financed at 5% as well as the 450,000 in variable current assets. ($625,000x.05)
Long term financing.
Can anyone tell me if one of these is correct? I have come out with these two figures but I am not sure which is the correct way to go.
EBIT: 200,000
LT Expense: 77500
ST Expense: +31250
EBT: =108750
Taxes (30%): -32625
Net Income: =76125 Or,
Long term financing 775000
Short term financing 625000
EBIT 200000
Less: Short term Interest 31250
Less: Long term Interest 77500
Less: Taxes 27375
EAT 63875
The correct way to calculate Lear's earnings after taxes under this financing plan is as follows:
1. Calculate the total interest expense for long-term financing:
Long-term financing amount = $775,000
Interest rate = 10%
Long-term interest expense = Long-term financing amount x Interest rate = $775,000 x 10% = $77,500
2. Calculate the total interest expense for short-term financing:
Short-term financing amount = $350,000 (half of permanent current assets)
Variable current assets = $450,000
Short-term financing amount for variable current assets = Variable current assets x Short-term interest rate = $450,000 x 5% = $22,500
Total short-term financing amount = Short-term financing amount + Short-term financing amount for variable current assets = $350,000 + $22,500 = $372,500
Short-term interest expense = Total short-term financing amount x Short-term interest rate = $372,500 x 5% = $18,625
3. Calculate earnings before taxes (EBT):
EBIT (earnings before interest and taxes) = $200,000
Less: Long-term interest expense = -$77,500
Less: Short-term interest expense = -$18,625
EBT = EBIT - Long-term interest expense - Short-term interest expense = $200,000 - $77,500 - $18,625 = $103,875
4. Calculate taxes:
Tax rate = 30%
Taxes = EBT x Tax rate = $103,875 x 30% = $31,162.50
5. Calculate earnings after taxes (EAT):
EAT = EBT - Taxes = $103,875 - $31,162.50 = $72,712.50
Therefore, Lear's earnings after taxes under this financing plan would be $72,712.50.
To determine Lear's earnings after taxes under this financing plan, you need to calculate the interest expenses and subtract them along with taxes from the earnings before interest and taxes (EBIT).
First, let's calculate the interest expenses for both long-term and short-term financing:
Long-term financing:
Fixed assets (to be financed with long-term debt): $600,000
Permanent current assets (to be financed with long-term debt): $175,000
Total assets to be financed with long-term debt: $600,000 + $175,000 = $775,000
Interest expense for long-term financing (at 10% interest rate): $775,000 * 0.10 = $77,500
Short-term financing:
Variable current assets (to be financed with short-term debt): $625,000
Interest expense for short-term financing (at 5% interest rate): $625,000 * 0.05 = $31,250
Now, let's calculate earnings after taxes (EAT):
EBIT: $200,000
Less: Short-term interest expense: $31,250
Less: Long-term interest expense: $77,500
EBT (Earnings Before Taxes): $200,000 - $31,250 - $77,500 = $91,250
Taxes (at 30% tax rate): $91,250 * 0.30 = $27,375
Earnings After Taxes (EAT): EBT - Taxes = $91,250 - $27,375 = $63,875
Therefore, the correct way to calculate Lear's earnings after taxes under this financing plan is $63,875.