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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

City Farm Insurance has collection centers across the country to speed up collections. The company also makes its disbursements from remote disbursement centers so the firm’s checks will take longer to clear the bank. Collection time has been reduced by two days and disbursement time increased by one day because of these policies. Excess funds are being invested in short-term instruments yielding 12 percent per annum.

b. How much can City Farm earn in dollars per year on short-term investments made possible by the freed-up cash?

Antivirus Inc. expects its sales next year to be \(2,500,000. Inventory and accounts receivable will increase \)480,000 to accommodate this sales level. The company has a steady profit margin of 15 percent with a 35 percent dividend payout. How much external financing will the firm have to seek? Assume there is no increase in liabilities other than that which will occur with the external financing

Route Canal Shipping Company has the following schedule for aging of accounts receivable:

c. If the firm likes to see its bills collected in 35 days, should it be satisfied with the average collection period?

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.

Lear Inc. has \(840,000 in current assets, \)370,000 of which are considered permanent current assets. In addition, the firm has \(640,000 invested in fixed assets.

a. Lear wishes to finance all fixed assets and half of its permanent current assets with long-term financing costing 8 percent. The balance will be financed with short-term financing, which currently costs 7 percent. Lear’s earnings before interest and taxes are \)240,000. Determine Lear’s earnings after taxes under this financing plan. The tax rate is 30 percent.
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