Lear Inc. has $970,000 in current assets, $435,000 of which are considered perma

Question

Lear Inc. has $970,000 in current assets, $435,000 of which are considered permanent current assets. In addition, the firm has $770,000 invested in fixed assets.

Lear wishes to finance all fixed assets and half of its permanent current assets with long-term financing costing 9 percent. The balance will be financed with short-term financing, which currently costs 4 percent. Lear’s earnings before interest and taxes are $370,000. Determine Lear’s earnings after taxes under this financing plan. The tax rate is 40 percent.

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 $370,000. What will be Lear’s earnings after taxes? The tax rate is 40 percent.

Lear Inc. has $970,000 in current assets, $435,000 of which are considered permanent current assets. In addition, the firm has $770,000 invested in fixed assets.

Explanation / Answer

a.

Financing all fixed assets and half of its permanent current assets with long-term financing i.e. Fixed assets + half of its permanent current assets = $770000 + 435000/2 = $770000 + $217500 = $987500

Balance with short term finance = $970000 - $217500 = $752500

Interest expense = $987500*9% + $752500*4% = $88875+$30100 = $118975

Earnings berfore interest and taxes = $370000

Earnings after taxes = ($370000 - $118975)(1-0.4) = $150615

b.

Financing all fixed assets and permanent current assets plus half of its temporary current assets with long-term financing i.e. $770000 + $435000 + $535000/2 = $1472500

Balance with short term finance = $535000/2 = $267500

Interest expense = $1472500*9% + $267500*4% = $132525+$10700 = $143225

Earnings berfore interest and taxes = $370000

Earnings after taxes = ($370000 - $143225)(1-0.4) = $136065

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