Lear, Inc., has $1,040,000 in current assets, $470,000 of which are considered p

Question

Lear, Inc., has $1,040,000 in current assets, $470,000 of which are considered permanent current assets. In addition, the firm has $840,000 invested in fixed assets.

Lear wishes to finance all fixed assets and half of its permanent current assets with long-term financing costing 10 percent. The balance will be financed with short-term financing, which currently costs 7 percent. Lear

Lear, Inc., has $1,040,000 in current assets, $470,000 of which are considered permanent current assets. In addition, the firm has $840,000 invested in fixed assets.

Explanation / Answer

Answer:

a. Calculation of Earnings After Tax (EAT) of Lear Inc.:

It is given that, all fixed assets and half of permanent current assets is financed from long term financing costing 10%;

Therefore, interest on long term finances will be 10% of ($ 840,000 + 50% of $ 470,000) that is equal to $ 107,500.

And, the balance of current assets are financed from short term finances costing 7%;

Therefore, interest on short term finances will be 7% of ($ 1,040,000 - 50% of $ 470,000) that is equal to $ 56,350.

Hence, total interest to be charged to income statement is $ 163,850.

Now,

Earning Before Interest and Tax (EBIT) = $ 440,000

Less: Interest Expenses as calculated = $ 163,850

Earning before Tax (EBT)                     = $ 276,150

Less: Tax @ 30%                               = $ 82,845

Earning After Tax (EAT)                       = $ 193,305

b. Calculation of Earnings After Tax (EAT) of Lear Inc.:

It is given that, all fixed assets, permanent current assets and half of temporary current assets is financed from long term financing costing 10%;

Therefore, interest on long term finances will be 10% of {$ 840,000 + $ 470,000 + 50% of ($ 1,040,000 - $ 470,000)} that is equal to $ 159,500

And, the balance half of temporary current assets are financed from short term finances costing 7%;

Therefore, interest on short term finances will be 7% of {50% of ($ 1,040,000 - $ 470,000)} that is equal to $ 19,950.

Hence, total interest to be charged to income statement is $ 179,450.

Now,

Earning Before Interest and Tax (EBIT) = $ 440,000

Less: Interest Expenses as calculated = $ 179,450

Earning before Tax (EBT)                     = $ 260,550

Less: Tax @ 30%                               = $ 78,165

Earning After Tax (EAT)                       = $ 182,385

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