Question

Sherlock Homes, a manufacturer of low cost mobile housing, has $5,000,000 in assets.

Temporary current assets | $2,000,000 | |

Permanent current assets | 1,550,000 | |

Capital assets | 1,450,000 | |

Total assets | $5,000,000 | |

Short-term rates are 10 percent. Long-term rates are 15 percent.
(Note that long‐term rates imply a return to any equity). Earnings
before interest and taxes are $1,060,000. The tax rate is 20
percent.

If long-term financing is perfectly matched (hedged) with long-term
asset needs, and the same is true of short-term financing, what
will earnings after taxes be?

Answer #1

Long-term Financing = Permanent Current Assets + Capital Assets

= $1,550,000 + $1,450,000 = $3,000,000

Short-term financing = Temporary Current Assets = $2,000,000

Total Interest Expense = Long-term interest expense - Short-term interest expense

= [$3,000,000*15%] + [$2,000,000*10%]

= $450,000 + $200,000 = $650,000

Earnings after taxes = [EBIT - Interest Expense] * [1 - t]

= [$1,060,000 - $650,000] * [1 - 20%]

= $410,000 * 0.80 = $328,000

**Earnings after taxes is $328,000**

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Sherlock Homes, a manufacturer of low cost mobile housing, has
$5,000,000 in assets.
Temporary current assets
$2,000,000
Permanent current assets
1,550,000
Capital assets
1,450,000
Total assets
$5,000,000
Short-term rates are 10 percent. Long-term rates are 15 percent.
(Note that long‐term rates imply a return to any equity). Earnings
before interest and taxes are $1,060,000. The tax rate is 20
percent.
If long-term financing is perfectly matched (hedged) with long-term
asset needs, and the same is true...

Sherlock Homes, a manufacturer of low cost mobile housing, has
$5,000,000 in assets.
Temporary current assets $2,000,000
Permanent current assets 1,550,000
Capital assets 1,450,000
Total assets $5,000,000
Short-term rates are 10 percent. Long-term rates are 15
percent. (Note that long‐term rates imply a return to any equity).
Earnings before interest and taxes are $1,060,000. The tax rate is
20 percent.
If long-term financing is perfectly matched (hedged) with
long-term asset needs, and the same is true of short-term
financing,...

Sherlock Homes, a manufacturer of low cost mobile housing, has
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Temporary current assets
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Permanent current assets
1,545,000
Capital assets
1,505,000
Total assets
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Short-term rates are 9 percent. Long-term rates are 14 percent.
(Note that long‐term rates imply a return to any equity). Earnings
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Temporary current assets
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Permanent current assets
1,530,000
Fixed assets
1,670,000
Total assets
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Short-term rates are 12 percent. Long-term rates are 17 percent.
Earnings before interest and taxes are $1,020,000. The tax rate is
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If long-term financing is perfectly matched (synchronized) with
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Temporary current assets
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Permanent current assets
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Fixed assets
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Total assets
$
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Short-term rates are 7 percent. Long-term rates are 12 percent.
Earnings before interest and taxes are $1,090,000. The tax rate is
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If long-term financing is perfectly matched (synchronized) with
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Colter Steel has $5,150,000 in assets.
Temporary Current Assets: $2,300,000
Permanent Current Assets: 1,565,000
Fixed Assets: 1,285,000
Total Assets: 5,150,000
Short-term rates are 7 percent. Long-term rates are 12 percent.
Earnings before interest and taxes are $1,090,000. The tax rate is
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If long-term financing is perfectly matched (synchronized) with
long-term asset needs, and the same is true of short-term
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Temporary current assets $ 2,500,000
Permanent current assets 1,575,000
Fixed assets 1,175,000
Total assets $ 5,250,000
Short-term rates are 9 percent. Long-term rates are 14 percent.
Earnings before interest and taxes are $1,110,000. The tax rate is
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If long-term financing is perfectly matched (synchronized) with
long-term asset needs, and the same is true of short-term
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Colter Steel has $4,800,000 in assets.
Temporary current assets
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Permanent current assets
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Fixed assets
1,670,000
Total assets
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Assume the term structure of interest rates becomes inverted,
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