Question

Lear, Inc. has $1,400,000 in current assets, $590,000 of which are considered permanent current assets. In addition, the firm has $840,000 invested in capital assets. a. Lear wishes to finance all capital assets and half of its permanent current assets with long-term financing costing 10 percent Short term financing currently costs 5 percent. Lear's earnings before interest and taxes are $440,000. Determine Lear's earnings after taxes under this financing plan. The tax rate is 30 percent. Earnings after taxes b. As an alternative, Lear might wish to finance all capital assets and permanent current assets plus half of its temporary current assets with long-term financing. The same interest rates apply as in part a. Earnings before interest and taxes will be $440,000. What will be Lear's earnings after taxes? The tax rate is 30 percent 5 Earnings after taxes SE c. Not available in Connect

Answer 1

(a):

Current assets – permanent current assets = temporary current assets.

So temporary current assets for Lear = 1,400,000 – 590,000 = $810,000

Short term interest expense = 5% * [810,000 + ½*590,000] = $55,250

Long term interest expense = 10% * [840,000 + ½*590,000] = $113,500

Thus total interest expense = 55,250+113,500 = $168,750

So earnings after tax = earnings before interest and tax – interest expense – tax

Earnings before interest and tax	440,000
less: interest expense	168,750
Earnings before tax	271,250
Tax @ 30% of earnings before tax	81,375
Earnings after tax	189,875

Thus earnings after taxes = $189,875

(b): Here long term interest expense = 10% *[840,000 + 590,000 + ½*810,000] = $183,500

Short term interest expense = 5%*[1/2*810,000] = $20,250

Total interest expense = 183,500+20,250 = $203,750

Earnings before interest and tax	440,000
less: interest expense	203,750
Earnings before tax	236,250
Tax @ 30% of earnings before tax	70,875
Earnings after tax	165,375

Thus earnings after tax = $165,375