Question

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 20 percent.

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

Earnings after taxes?

Answer 1

Long term financing = Permanent current assets + Fixed costs

= $1,565,000 + $1,285,000

= $2,850,000

Long term interest expense = $2,850,000 * 12%

= $342,000

Short term financing = Temporary current assets

= $2,300,000

Short term interest expense = $2,300,000 * 7%

= $161,000

Total interest expense = Long term interest expense + Short term interest expense

= $342,000 + $161,000

= $503,000

Earnings before taxes = Earnings before interest and taxes - Total interest expense

= $1,090,000 - $503,000

= $587,000

Earnings after taxes = $587,000 - ($587,000 * 20%)

= $587,000 - $117,400

= $469,600