Lear Inc. has $870,000 in current assets, $385,000 of which are considered permanent current assets. In...

Lear Inc. has $870,000 in current assets, $385,000 of which are considered permanent current assets. In addition, the firm has $670,000 invested in fixed assets.

a. Lear wishes to finance all fixed assets and half of its permanent current assets with long-term financing costing 8 percent. The balance will be financed with short-term financing, which currently costs 6 percent. Lear’s earnings before interest and taxes are $270,000. Determine Lear’s earnings after taxes under this financing plan. The tax rate is 40 percent.

b. As an alternative, Lear might wish to finance all fixed assets and permanent current assets plus half of its temporary current assets with long-term financing and the balance with short-term financing. The same interest rates apply as in part a. Earnings before interest and taxes will be $270,000. What will be Lear’s earnings after taxes? The tax rate is 40 percent.

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Expert Solution

Calculation of Earnings After Tax:

Earning Before Interest andTax	$ 270000
Less: Interest on Long Term Financing	$ 69000
Interest on Short Term Financing	$ 40650
Earning Before Tax	$ 160350
Less: Tax @ 40%	$ 64140
Earning After Tax	$ 96210

Working Note:

1. Long Term Financing Cost

Fixed Assets = $ 670000

Permanent Current Assets (1/2*385000) = $ 192500

Total = $ 862500

Interest = 8% of $ 862500 = $ 69000

2. Short Term Financing Cost

Permanent Current Assets (1/2*385000) = $ 192500

Temporary Current Assets (870000-385000) = $ 485000

Total = $ 677500

Interest = 6% of $ 677500 = $ 40650

Calculation of Earning After Tax

Earning Before Interest and Tax	$ 270000
Less: Interest on Long Term Finance	$ 103800
Interest on Short Term Finance	$ 14550
Earning Before Tax	$ 151650
Less: Tax @ 40% Earning After Tax	$ 60660 $ 90990

Working Note:

1.Long Term Finance Cost

Fixed Assets = $ 670000

Permanent Current Assets = $ 385000

Temporary Current Assets ( 1/2*485000) = $ 242500

Total = $ 1297500

Interest = 8% of $ 1297500 = $ 103800

2. Short Term Finance Cost

Temporary Current Assets (1/2*485000) = $ 242500

Interest = 6% of 242500 = $ 14550

ekkarill92 answered 7 months ago

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