Question

Hicks Health Clubs, Inc., expects to generate an annual EBIT of $513,000 and needs to obtain financing for $1,090,000 of assets. Their tax bracket is 39%. If the firm goes with a short-term financing plan, their rate will be 7.0 percent, and with a long-term financing plan their rate will be 8.0 percent. By how much will their earnings after tax change if they choose the more aggressive financing plan instead of the more conservative?

$6,649

$10,649

($6,649)

($10,649)

Answer 1

HI Aggresive financing plan comrises of relying on more short term finaning

So in more aggresive plan their interest rate =7%

Hence consider it for 1 year

so total interest rate = 1090000*7%= $76,300

So profit before tax= 513000-763000= $436,700

And tax rate = 39%

hence Profit after tax= Profit before tax*(1-tax)

=436700*61%= $266,387

NOw in conservative plan= total interest = 8%*1090000= $87,200

So profit before tax= $513000-87200= $425,800

and profit after tax= 61%*425800= $259,738

So earning after tax change if more aggresive plan= 266,387-259,738= $6,649

Thanks