Question

Colter Steel has $4,550,000 in assets.

Temporary current assets	$	1,100,000
Permanent current assets		1,505,000
Fixed assets		1,945,000
Total assets	$	4,550,000

Assume the term structure of interest rates becomes inverted, with short-term rates going to 13 percent and long-term rates 2 percentage points lower than short-term rates. Earnings before interest and taxes are $970,000. 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?

Answer 1

Calculation of Earnings after taxes
	$
Long-term financing equals:
Permanent current assets	1,505,000.00
Fixed assets	1,945,000.00
	3,450,000.00
Short-term financing equals:
Temporary current assets	1,100,000.00
Long-term interest expense (11% × $3,450,000)	379,500.00
Short-term interest expense (13% × $1,100,000)	143,000.00
Total interest expense	522,500.00
Earnings before interest and taxes	970,000.00
Interest expense	522,500.00
Earnings before taxes	447,500.00
Taxes (20%)	89,500.00
Earnings after taxes	358,000.00