Question

Currently, Atlas Tours has $6.04 million in assets. This is a peak six-month period. During the other six months, temporary current assets drop to $480,000.

  

Temporary current assets	$1,280,000
Permanent current assets	1,960,000
Capital assets	2,800,000
Total assets	$6,040,000

  

Short-term rates are 5 percent. Long-term rates are 7 percent. Annual earnings before interest and taxes are $1,160,000. The tax rate is 38 percent.

a. If the assets are perfectly hedged throughout the year, what will earnings after taxes be? (Enter answers in whole dollar, not in million.)

Earnings after taxes            $

b. If short-term interest rates increase to 7 percent when assets are at their lowest level, what will earnings after taxes be? For an example of perfectly hedged plans, see Figure 6–8

  

Earnings after taxes            $

Answer 1

a). Long -term Financing Assets = Permanent Current Assets + Capital Assets

= $1,960,000 + $2,800,000 = $4,760,000

Short-term Financing Assets = Temporary Current Assets(First Six Months) + Temporary Current Assets(Last Six Months)

= $1,280,000 + $480,000 = $1,760,000

Total Interest Expense = [Long-term Financing Assets * long-term rates] + [Short-term Financing Assets * Short-term rates]

= [$4,760,000 * 7%] + [$1,760,000 * 5%]

= $333,200 + $88,000 = $421,200

Earnings after taxes = [EBIT - Interest] * [1 - t]

= [$1,160,000 - $421,200] * [1 - 0.38]

= $738,800 * 0.62 = $458,056

b). Total Interest Expense = [Long-term Financing Assets * long-term rates] + [Short-term Financing Assets * Short-term rates]

= [$4,760,000 * 7%] + [$1,280,000 * 5%] + [$480,000 * 7%]

= $333,200 + $64,000 + $33,600 = $430,800

Earnings after taxes = [EBIT - Interest] * [1 - t]

= [$1,160,000 - $430,800] * [1 - 0.38]

= $729,200 * 0.62 = $452,104