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
To determine Lear's earnings after taxes under this financing plan, we need to calculate the interest expense and subtract it from the earnings before interest and taxes (EBIT). Then, we can apply the tax rate to the earnings before taxes (EBT) to calculate the net income.
Here's how you can calculate it:
1. Calculate the amount of assets to be financed with long-term debt:
Permanent current assets financed with long-term debt: $175,000
Fixed assets financed with long-term debt: $600,000
Total assets to be financed with long-term debt: $175,000 + $600,000 = $775,000
2. Calculate the amount of short-term financing:
Remaining permanent current assets financed with short-term financing: $175,000
Variable current assets financed with short-term financing: $800,000 - $350,000 - $175,000 = $275,000
3. Calculate the interest expense for long-term financing:
Long-term financing at 10% interest rate on $775,000: $775,000 * 10% = $77,500
4. Calculate the interest expense for short-term financing:
Short-term financing at 5% interest rate on $175,000: $175,000 * 5% = $8,750
Short-term financing at 5% interest rate on $275,000: $275,000 * 5% = $13,750
Total short-term interest expense: $8,750 + $13,750 = $22,500
5. Calculate the earnings before taxes (EBT):
EBT = EBIT - Long-term interest expense - Short-term interest expense
EBT = $200,000 - $77,500 - $22,500 = $100,000
6. Apply the tax rate to calculate the earnings after taxes (EAT):
Taxes = EBT * Tax rate
Taxes = $100,000 * 30% = $30,000
EAT = EBT - Taxes
EAT = $100,000 - $30,000 = $70,000
Therefore, Lear's earnings after taxes under this financing plan would be $70,000.