Question

Guardian Inc. is trying to develop an asset-financing plan. The firm has $410,000 in temporary current assets and $310,000 in permanent current assets. Guardian also has $510,000 in fixed assets. Assume a tax rate of 30 percent. a. Construct two alternative financing plans for Guardian. One of the plans should be conservative, with 70 percent of assets financed by long-term sources, and the other should be aggressive, with only 56.25 percent of assets financed by long-term sources. The current interest rate is 16 percent on long-term funds and 8 percent on short-term financing. Compute the annual interest payments under each plan. b. Given that Guardian’s earnings before interest and taxes are $290,000, calculate earnings after taxes for each of your alternatives. c. What would the annual interest and earnings after taxes for the conservative and aggressive strategies be if the short-term and long-term interest rates were reversed?

Answer 1

a) Annual Inrest Amount

	Conservative Plan	Aggressive Plan
Total Current Asset	$                7,20,000.00	$                7,20,000.00
Total Fixed Asset	$                5,10,000.00	$                5,10,000.00
Total Asset	$              12,30,000.00	$              12,30,000.00
Long Term Finance(%)	70.00%	56.25%
Long Term Finance($)	$                8,61,000.00	$                6,91,875.00
ShortTerm Finance(%)	30.00%	43.75%
ShortTerm Finance($)	$                3,69,000.00	$                5,38,125.00
Annual Interest	$                1,67,280.00	$                1,53,750.00
Interest Rate
Long Term Finance	16%	16%
Short Term Finance	8%	8%

---------------------------------------------------------------------------------------------------------------------------------------

Earning after tax schedule ain both cases

	Conservative Plan	Aggressive Plan
EBIT	$            2,90,000.00	$            2,90,000.00
Interest	$            1,67,280.00	$            1,53,750.00
Tax=30%x(EBIT-Interest)	$                36,816.00	$                40,875.00
Earning After Tax	$                85,904.00	$                95,375.00

-----------------------------------------------------------------------------------

Effect on annual interest and earning after tax if ST & LT interest rates are reversed>

Scenario after LT & ST interest rate reversed
	Conservative Plan	Aggressive Plan
Total Current Asset	$                7,20,000.00	$                7,20,000.00
Total Fixed Asset	$                5,10,000.00	$                5,10,000.00
Total Asset	$              12,30,000.00	$              12,30,000.00
Long Term Finance(%)	70.00%	56.25%
Long Term Finance($)	$                8,61,000.00	$                6,91,875.00
ShortTerm Finance(%)	30.00%	43.75%
ShortTerm Finance($)	$                3,69,000.00	$                5,38,125.00
Annual Interest	$                1,27,920.00	$                1,53,750.00
Interest Rate
Long Term Finance	8%	16%
Short Term Finance	16%	8%

	Conservative Plan	Aggressive Plan
EBIT	$            2,90,000.00	$            2,90,000.00
Interest	$            1,27,920.00	$            1,53,750.00
Tax=30%x(EBIT-Interest)	$                48,624.00	$                40,875.00
Earning After Tax	$            1,13,456.00	$                95,375.00