Amile Corporation has a total of $1,000,000 in current assets. 15% of current as

Question

Amile Corporation has a total of $1,000,000 in current assets. 15% of current assets are permanent current assets. The company has $700,000 in fixed assets. The current short-term rate is 6.5% while the current long-term rate is 9%. The company has a tax rate of 30%.

The company is deciding between two financing plans. The conservative plan calls for 40% of temporary current assets to be financed by short-term sources with the remainder of assets financed by long-term sources. The more aggressive plan calls for all temporary current assets and permanent current assets to be financed by short-term sources and all fixed assets to be financed by long-term sources.

If Amile Corporation's EBIT is $525,000, calculate net income under each alternative. Then determine which of the following answer choices is true.

Select one:

a. Total interest expense is greater under the more aggressive plan.

b. Net income under the conservative plan is $245,000 and $239,000 under the more aggressive plan.

c. Short-term interest expense is higher under the more conservative plan.

d. Net income under the conservative plan is $379,000 and $385,000 under the more aggressive plan.

e. Net income under the conservative plan is $266,350 and $277,900 under the more aggressive plan.

Explanation / Answer

Total asset =current +fixed

         = 1000000+700000= 1,700,000

Temporary current asset = 1,000,000(1-.15 permanent)=850,000

1)

correct option is "E" -Net income under the conservative plan is $266,350 and $277,900 under the more aggressive plan

conservative plan Aggressive plan Financing Interest Financing Interest asset financed by short term sources 340000   [850000*.40] 340000*.065= 22100 1,000,000 1000000*.065= 65000 Long term sources 1,700,000-340,000= 1360000 1360000*.09=122400 700,000 700000*.09= 63000 Total interest 144500 128000

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