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Guardian Inc. is trying to develop an asset-financing plan. The firm has $510,00

ID: 2818190 • Letter: G

Question

Guardian Inc. is trying to develop an asset-financing plan. The firm has $510,000 in temporary current assets and $410,000 in permanent current assets. Guardian also has $610,000 in fixed assets. Assume a tax rate of 40 percent.

a. Construct two alternative financing plans for Guardian. One of the plans should be conservative, with 90 percent of assets financed by long-term sources, and the other should be aggressive, with only 56.25 percent of assets financed by long-term sources. The current interest rate is 12 percent on long-term funds and 8 percent on short-term financing. Compute the annual interest payments under each plan.

b. Given that Guardian’s earnings before interest and taxes are $390,000, calculate earnings after taxes for each of your alternatives.

c. What would the annual interest and earnings after taxes for the conservative and aggressive strategies be if the short-term and long-term interest rates were reversed?

Explanation / Answer

temporary current asset

510000

permanent current asset

410000

fixed assets

610000

total assets

1530000

conservative plan-90% assets with long term finance and 10% with short term finance

Amount of interest

assets financed from long term = 1530000*90%

1377000

1377000*12%

165240

assets financed from short term = 1530000*10%

153000

153000*8%

12240

total interest expense under conservative plan

177480

other plan-56.25% assets with long term finance and 43.75% with short term finance

Amount of interest

assets financed from long term = 1530000*90%

1530000*56.25%

860625

860625*12%

103275

assets financed from short term = 1530000*10%

1530000*43.75%

669375

669375*8%

53550

total interest expense under conservative plan

156825

Conservative plan

Other plan

B-

EBIT

390000

390000

less interest

177480

156825

EBT

212520

233175

less taxes-40%

85008

93270

EAT

127512

139905

C-

conservative plan-90% assets with long term finance and 10% with short term finance

Amount of interest

assets financed from long term = 1530000*90%

1530000*90%

1377000

1377000*8%

110160

assets financed from short term = 1530000*10%

1530000*10%

153000

153000*12%

18360

total interest expense under conservative plan

128520

other plan-56.25% assets with long term finance and 43.75% with short term finance

Amount of interest

assets financed from long term = 1530000*90%

1530000*56.25%

860625

860625*8%

68850

assets financed from short term = 1530000*10%

1530000*43.75%

669375

669375*12%

80325

total interest expense under conservative plan

149175

Conservative plan

Other plan

EBIT

390000

390000

less interest

128520

149175

EBT

261480

240825

less taxes-40%

104592

96330

EAT

156888

144495

temporary current asset

510000

permanent current asset

410000

fixed assets

610000

total assets

1530000

conservative plan-90% assets with long term finance and 10% with short term finance

Amount of interest

assets financed from long term = 1530000*90%

1377000

1377000*12%

165240

assets financed from short term = 1530000*10%

153000

153000*8%

12240

total interest expense under conservative plan

177480

other plan-56.25% assets with long term finance and 43.75% with short term finance

Amount of interest

assets financed from long term = 1530000*90%

1530000*56.25%

860625

860625*12%

103275

assets financed from short term = 1530000*10%

1530000*43.75%

669375

669375*8%

53550

total interest expense under conservative plan

156825

Conservative plan

Other plan

B-

EBIT

390000

390000

less interest

177480

156825

EBT

212520

233175

less taxes-40%

85008

93270

EAT

127512

139905

C-

conservative plan-90% assets with long term finance and 10% with short term finance

Amount of interest

assets financed from long term = 1530000*90%

1530000*90%

1377000

1377000*8%

110160

assets financed from short term = 1530000*10%

1530000*10%

153000

153000*12%

18360

total interest expense under conservative plan

128520

other plan-56.25% assets with long term finance and 43.75% with short term finance

Amount of interest

assets financed from long term = 1530000*90%

1530000*56.25%

860625

860625*8%

68850

assets financed from short term = 1530000*10%

1530000*43.75%

669375

669375*12%

80325

total interest expense under conservative plan

149175

Conservative plan

Other plan

EBIT

390000

390000

less interest

128520

149175

EBT

261480

240825

less taxes-40%

104592

96330

EAT

156888

144495