Chapter 3: Q15BP_b (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.
b. As an alternative, Lear might wish to finance all fixed assets and permanent current assets plus half of its temporary current assets with long-term financing and the balance with short-term financing. The same interest rates apply as in part a. Earnings before interest and taxes will be $240,000. What will be Lear’s earnings after taxes? The tax rate is 30 percent.

Short Answer

Expert verified

The earnings after tax will be $86,765 in the alternative 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 in the alternative financing plan

The interest expense will be $116,050.

$\begin{array}{rcl} L o n g t e m i n t e r e s t e x p e n s e & = & A s s e t s t o b e f i n a n c e d \times I n t e r e s t r a t e \\ = & ($ 640, 000 + $ 370, 000 + \frac{1}{2} \times $ 470, 000) \times 8 % \\ = & $ 1, 245, 000 \times 8 % \\ = & $ 99, 600 \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 \times \frac{1}{2}) \times 7 % \\ = & $ 235, 000 \times 7 % \\ = & $ 16, 450 \end{array}$

Calculation of earnings after tax

The earnings after tax will be $86,765.

$\begin{array}{rcl} E a r n i n g a f t e r t a x e s & = & E a r n i n g 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 - T a x e s \\ = & $ 240, 000 - $ 116, 050 - $ 37, 185 \\ = & $ 86, 765 \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

October	1,250
November	2,250
December	4,500
January	3,500
Total units	11,500

Short Answer

Step by step solution

Information given in the question

Calculation of interest expense in the alternative financing plan

Calculation of earnings after tax

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