Question

Lear Inc. has $890,000 in current assets, $395,000 of which are considered permanent current assets. In addition, the firm has $690,000 invested in fixed assets.    
  
a. Lear wishes to finance all fixed assets and half of its permanent current assets with long-term financing costing 10 percent. The balance will be financed with short-term financing, which currently costs 4 percent. Lear’s earnings before interest and taxes are $290,000. 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 $290,000. What will be Lear’s earnings after taxes? The tax rate is 40 percent.
  

Answer 1

A) Interest on financing fixed assets = 0.10*690,000 = $69,000

Interest on permanent current assets = 395,000/2*0.10 + 395,000/2*0.04 = $27,650

Interest on current assets = $890,000*0.04 = $35,600

EBIT = $290,000

Less interest = $96,650+35,600 = $132,250

EBT = $157,750

Less tax@40% = 157,750*0.60

Earning after tax = $94,650

B) Interest on Fixed Assets = $69,000

Interest on permanent and current assets = (395,000+890,000/2)*0.10 = $64,250

Interest on remaining current assets = $445000*0.04 = $17,800

Total Interest = $69,000+64,500+17,500 = $151,050

EBIT = $290,000

Less: Interest = $151,050

EBT: 138,950

Less Tax: 138,950*0.60

EAT = $83,370