Chapter 3: 12BP (page 187)

Colter Steel has $4,200,000 in assets.
Temporary current assets
$1,000,000
Permanent current assets
$2,000,000
Fixed assets
$1,200,000
Total assets
$4,200,000
Short-term rates are 8 percent. Long-term rates are 13 percent. Earnings before interest and taxes are $996,000. The tax rate is 40 percent. If long-term financing is perfectly matched (synchronized) with long-term asset needs, and the same is true of short-term financing, what will earnings after taxes be? For a graphical example of perfectly matched plans, see Figure 6-5.

Short Answer

Expert verified

The earnings after taxes will be $300,000.

Step by step solution

Information given in the question

The following information is provided:

Long-term interest rates = 13%

Short-term interest rates =8%

Earnings before interest and taxes = $996,000

Tax rate = 40%

Calculation of long-term financing

The long-term financing is $3,200,000.

$L o n g t e r m f i n a n c i n g = P e r m a n e n t c u r r e n t a s s e t s + F i x e d a s s e t s = 2, 000, 000 + 1, 200, 000 = 3, 200, 00$

Calculation of Short-term financing

The short-term financing is $1,000,000. This is the amount of current temporary assets of the organization

Calculation of interest expense

The interest expense is $496,000

$I n t e r e s t E x p e n s e = L o n g t e r m I n t e r n e t e x p e n s e s + S h o r t t e r m I n t e r n e t e x p e n s e s = (3, 200, 000 \times 13 %) + (1, 000, 000 \times 8 %) = $ 416, 000 + $ 80, 000 = $ 496, 000$

Calculation of earnings after taxes

The earning after taxes is $300,000.

$E a r n i n g s a f t e r t a x e s = E a r n i n g s b e f o r e i n t e r e s t a n d t a x e s - I n t e r n e t e x p e n s e s - T a x e s = $ 996, 000 - $ 496, 000 - $ 200, 000 = $ 300, 000$

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January	\(28,000
February	\)19,000
March	\(12,000
April	\)14,000
May	\(8,000
June	\)6,000
July	\(22,000
August	\)26,000
September	\(29,000
October	\)34,000
November	\(42,000
December	\)24,000
Total annual sales	\(264,000

Short Answer

Step by step solution

Information given in the question

Calculation of long-term financing

Calculation of Short-term financing

Calculation of interest expense

Calculation of earnings after taxes

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Temporary current assets	\)1,000,000
Permanent current assets	\(2,000,000
Fixed assets	\)1,200,000
Total assets	\(4,200,000