Lear Inc. has $870,000 in current assets, $385,000 of which are considered perma

Question

Lear Inc. has $870,000 in current assets, $385,000 of which are considered permanent current assets. In addition, the firm has $670,000 invested in fixed assets.    
  
a. Lear wishes to finance all fixed assets and half of its permanent current assets with long-term financing costing 8 percent. The balance will be financed with short-term financing, which currently costs 6 percent. Lear’s earnings before interest and taxes are $270,000. Determine Lear’s earnings after taxes under this financing plan. The tax rate is 40 percent.

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 $270,000. What will be Lear’s earnings after taxes? The tax rate is 40 percent.

Explanation / Answer

A Investment in fixed assets        670,000.00 Investment in permanent current assets        385,000.00 Half of Permanent current assets        192,500.00 Funds through Long Term Financing Investment in fixed assets + Invest in half of permanent current assets        862,500.00 Interest rate 8% funds raised through Short term financing currents assets - half of current permament assets        677,500.00 Interest rate 6% Total Interest Cost =    109,650.00 Earnings before interest and taxes        270,000.00 Less : Interest          109,650.00 Earning before taxes        160,350.00 taxes @40%          64,140.00 Earnings after Taxes          96,210.00 B Funds through Long Term Financing Investment in fixed assets        670,000.00 Investment in permanent current assets        385,000.00 half of Temparary current assets = (870000-385000)*50%        242,500.00 Total Long term funds    1,297,500.00 Longterm finance interest rate 8% Funds through short Term Financing half of Temparary current assets = (870000-385000)*50%        242,500.00 shortterm finance interest rate 6% Earnings before interest and taxes        270,000.00 Less : Interest          118,350.00 Earning before taxes        151,650.00 taxes @40%          60,660.00 Earnings after Taxes          90,990.00

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