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Chapter 3: Q12BP (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

01

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%

02

Calculation of long-term financing 

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

Longtermfinancing=Permanentcurrentasset+Fixedasset=$2,000,000+$1,200,000=$3,200,000

03

Calculation of short-term financing 

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

04

Calculation of interest expense 

The interest expense is $496,000.

Interestexpense=Long-terminterestexpenses+Short-terminterestexpenses=($3,200,000×13%)+($1,000,000×8%)=$416,000+$80,000=$416,000

05

Calculation of earnings after taxes 

The earning after taxes is $300,000.

Earningsaftertaxes=Earningsbeforeinterestandtaxes-Interestexpenses=$996,000-$496,000-$200,000=$300,000

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Most popular questions from this chapter

Esquire Products Inc. expects the following monthly sales:

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

Cash sales are 40 percent in a given month, with the remainder going into accounts receivable. All receivables are collected in the month following the sale. Esquire sells all of its goods for \)2 each and produces them for $1 each. Esquire uses level production, and average monthly production is equal to annual production divided by 12.

a. Generate a monthly production and inventory schedule in units. Beginning inventory in January is 12,000 units. (Note: To do part a, you should work in terms of units of production and units of sales.)

Guardian Inc. is trying to develop an asset financing plan. The firm has \(400,000 in temporary current assets and \)300,000 in permanent current assets. Guardian also has \(500,000 in fixed assets. Assume a tax rate of 40 percent.

b. Given that Guardian’s earnings before interest and taxes are \)200,000, calculate earnings after taxes for each of your alternatives.

What are the 5 Cs of credit that are sometimes used by bankers and others to determine whether a potential loan will be repaid?

Henderson Office Supply is considering a more liberal credit policy to increase sales, but expects that 9 percent of the new accounts will be uncollectible. Collection costs are 6 percent of new sales, production and selling costs are 74 percent, and accounts receivable turnover is four times. Assume income taxes of 20 percent and an increase in sales of $65,000. No other asset build-up will be required to service the new accounts.

e. Given the income determined in part b and the investment determined in part d, should Henderson extend more liberal credit terms?

In Problem 18, what long-term interest rate would represent a break-even point between using short-term financing as described in part a and long-term financing? (Hint: Divide the interest payments in 18a by the amount of total funds provided for the six months and multiply by 12.)
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