Question

Lear Inc. has $850,000 in current assets, $375,000 of which are considered permanent current assets. In addition, the firm has $650,000 invested in fixed assets. a. Lear wishes to finance all fixed assets and half of its permanent current assets with long-term financing costing 9 percent. The balance will be financed with short-term financing, which currently costs 4 percent. Lear’s earnings before interest and taxes are $250,000. Determine Lear’s earnings after taxes under this financing plan. The tax rate is 40 percent.

Answer 1

Answer: $88,875

Step-by-step explanation:

The following can be deduced from the question:

The Total Long term loan financing will be:

= $650,000 + ($375,000/2)

= $650,000 + $187,500

= $837,500

This implies that Long term debt financing is $837,500

Then, short term debt financing will be calculated as:

= ($850,000 - $375,000) + $187,500

= $475,000 + $187,500

= $662,500

The Interest expense will be calculated as:

= ($837,500×9%) + ($662,500×4%)

=($837,500 × 0.09)+($662,500 × 0.04)

= $75,375+$26,500

= $101,875.

The Profit before tax will be calculated as:

= EBIT - Interest expenses

= $250,000 - $101,875

= $148,125.

Profit after tax will then be:

= $148,125 × (1 - 40%)

= $148,125 × 60%

= $148,125 × 0.6

= $88,875.

Therefore, Lear’s earnings after taxes under this financing plan is $88,875.