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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

01

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%

02

Calculation of interest expense

The interest expense will be $111,850

Longterminterestexpense=Assetstobefinanced×Interestrate=($640,000+12×370,000)×8%=$825,000×8%=$66,000

ShortTerminterestexpense=Assetstobefinanced×Interestrate=($470,000+12×370,000)×7%=$655,000×7%=$45,850

03

Calculation of earnings after tax

The earnings after tax will be $89,705.

Earningsaftertaxes=Earningsbeforeinterestandtaxes-Interestexpenses-=$240,000-$111,850-$38,445=$89,705

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Most popular questions from this chapter

What is the prime interest rate? How does the average bank customer fare in regard to the prime interest rate?

Question: Nowlin Pipe & Steel has projected sales of 72,000 pipes this year, an ordering cost of \(6 per order, and carrying costs of \)2.40 per pipe.

b. How many orders will be placed during the year?

Assume that Hogan Surgical Instruments Co. has \(2,500,000 in assets. If it goes with a low-liquidity plan for the assets, it can earn a return of 18 percent, but with a high-liquidity plan, the return will be 14 percent. If the firm goes with a short-term financing plan, the financing costs on the \)2,500,000 will be 10 percent, and with a long-term financing plan, the financing costs on the $2,500,000 will be 12 percent. (Review Table 6-11 for parts a, b, and c of this problem.)

a. Compute the anticipated return after financing costs with the most aggressive asset financing mix.

b. Compute the anticipated return after financing costs with the most conservative asset financing mix.

c. Compute the anticipated return after financing costs with the two moderate approaches to the asset financing mix.

d. Would you necessarily accept the plan with the highest return after financing costs? Briefly explain.

In the management of cash and marketable securities, why should the primary concern be for safety and liquidity rather than maximization of profit?

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.

c. Determine a cash payments schedule for January through December. The production costs (\)1 per unit produced) are paid for in the month in which they occur. Other cash payments (besides those for production costs) are $7,400 per month.
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