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Lear, Inc. has $1,350,000 in current assets, $570,000 of which are considered permanent current assets. In...

Lear, Inc. has $1,350,000 in current assets, $570,000 of which are considered permanent current assets. In addition, the firm has $820,000 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 $420,000. 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 $420,000. What will be Lear’s earnings after taxes? The tax rate is 30 percent.

Earnings after taxes $

c. Not available in Connect.

Expert Solution

Part a)

Permanent current assets = $570,000; Half of permanent current assets = Permanent current assets/2 = $570,000/2 = $285,000; capital assets = $820,000

Long-term finance = All capital assets + Half of permanent current assets = $820,000+$285,000 = $1,105,000

Interest on long-term finance = Long-term finance*10% = $1,105,000*10% = $110,500

Earnings before taxes = Earnings before interest and taxes - Interest = $420,000 - $110,500 = $309,500

Taxes = Earnings before taxes*tax rate = $309,500*30% = $92,850

Earnings after taxes = Earnings before taxes - Taxes = $309,500 - $92,850 = $216,650

Part b)

Permanent current assets = $570,000; Temporary current assets = Current assets - Permanent current assets = $1,350,000 - $570,000 = $780,000; Half of temporary current assets = Temporary current assets/2 = $780,000/2 = $390,000 capital assets = $820,000

Long-term finance = All capital assets + Half of temporary current assets + permanent current assets = $820,000+$390,000+$570,000 = $1,780,000

Interest on long-term finance = Long-term finance*10% = $1,780,000*10% = $178,000

Earnings before taxes = Earnings before interest and taxes - Interest = $420,000 - $178,000 = $242,000

Taxes = Earnings before taxes*tax rate = $242,000*30% = $72,600

Earnings after taxes = Earnings before taxes - Taxes = $242,000 - $72,600 = $169,400

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