Question

Colter Steel has $5,250,000 in assets.

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 40 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?

Answer 1

Long-term financing = Permanent current assets + Fixed assets = $1,575,000 + $1,175,000 = $2,750,000

Short-term financing = Temporary current assets = $2,500,000

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

Total interest expense = ($2,750,000 * 0.14) + ($2,500,000 * 0.09)

Total interest expense = $610,000

Earnings before interest and taxes	$1,110,000
Interest expense	$610,000
Earnings before taxes	$500,000
Taxes (40%)	$200,000
Earnings after taxes	$300,000