I am trying this one more time
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
63,875 is the answer I came up with. I hope this is the correct answer, but not 100% positive
To determine Lear's earnings after taxes under this financing plan, you can calculate it using the following steps:
1. Calculate the total assets to be financed with long-term debt:
Permanent current assets to be financed = $175,000 (half of working capital)
Fixed assets to be financed = $600,000
Total assets to be financed with long-term debt = $175,000 + $600,000 = $775,000
2. Calculate the interest expense on long-term debt:
Long-term debt interest rate = 10%
Long-term debt interest expense = Total assets financed with long-term debt x Long-term debt interest rate
Long-term debt interest expense = $775,000 x 0.10 = $77,500
3. Calculate the interest expense on short-term debt:
Short-term debt interest rate = 5%
Short-term debt interest expense = Variable current assets x Short-term debt interest rate
Variable current assets = Current assets - Permanent current assets
Variable current assets = $800,000 - $350,000 = $450,000
Short-term debt interest expense = $450,000 x 0.05 = $22,500
4. Calculate Earnings Before Taxes (EBT):
Earnings Before Taxes = Earnings Before Interest and Taxes (EBIT) - Long-term debt interest expense - Short-term debt interest expense
Earnings Before Taxes = $200,000 - $77,500 - $22,500 = $100,000
5. Calculate Taxes:
Tax rate = 30%
Taxes = Earnings Before Taxes x Tax rate
Taxes = $100,000 x 0.30 = $30,000
6. Calculate Earnings After Taxes (EAT):
Earnings After Taxes = Earnings Before Taxes - Taxes
Earnings After Taxes = $100,000 - $30,000 = $70,000
Therefore, Lear's earnings after taxes under this financing plan would be $70,000.