Chapter 3: Q15BP_a (page 187)

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.

Short Answer

Expert verified

The earnings after tax will be $89,705 in the first plan.

Step by step solution

Information given in the question

The following information is provided:

Temporary current assets =$470,000

Permanent current assets =$370,000

Fixed assets =$640,000

Total assets =$1,480,000

Tax rate = 30%

Calculation of interest expense

The interest expense will be $111,850

$\begin{array}{rcl} L o n g t e r m i n t e r e s t e x p e n s e & = & A s s e t s t o b e f i n a n c e d \times I n t e r e s t r a t e \\ = & ($ 640, 000 + \frac{1}{2} \times 370, 000) \times 8 % \\ = & $ 825, 000 \times 8 % \\ = & $ 66, 000 \end{array}$

$\begin{array}{rcl} S h o r t T e r m i n t e r e s t e x p e n s e & = & A s s e t s t o b e f i n a n c e d \times I n t e r e s t r a t e \\ = & ($ 470, 000 + \frac{1}{2} \times 370, 000) \times 7 % \\ = & $ 655, 000 \times 7 % \\ = & $ 45, 850 \end{array}$

Calculation of earnings after tax

The earnings after tax will be $89,705.

$\begin{array}{rcl} 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 e s t e x p e n s e s - \\ = & $ 240, 000 - $ 111, 850 - $ 38, 445 \\ = & $ 89, 705 \end{array}$

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January	\(100,000
February	\)93,000
March	\(25,000
April	\)25,000
May	\(20,000
June	\)35,000
July	\(45,000
August	\)45,000
September	\(55,000
October	\)85,000
November	\(105,000
December	\)123,000
Total annual sales	\(756,000

March	3,250
April	7,250
May	11,500
June	9,500
Total units	31,500

Short Answer

Step by step solution

Information given in the question

Calculation of interest expense

Calculation of earnings after tax

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