Question

Colter Steel has $4,800,000 in assets. Temporary current assets $ 1,600,000 Permanent current assets 1,530,000 Fixed assets 1,670,000 Total assets $ 4,800,000 Assume the term structure of interest rates becomes inverted, with short-term rates going to 12 percent and long-term rates 2 percentage points lower than short-term rates. Earnings before interest and taxes are $1,020,000. The tax rate is 40 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

Long-term financing need:

Permanent current assets $1,530,000

Fixed assets $1,670,000

Total $3,200,000

Short-term financing need:

Temporary current assets $1,600,000

Long-term interest expense $320,000

Short-term interest expense $192,000

Total interest expense $512,000

EBIT $1,020,000

Interest expense $512,000

Earnings before taxes $508,000

Taxes $203,200

Earnings after taxes $304,800

Workings:

Long-term interest expense =10%× $3,200,000 = $320,000

Short-term interest expense =12% × $1,600,000 = $192,000

Taxes = 40% × $508,000 = $203,200