Lear Inc. has $940,000 in current assets, $420,000 of which are considered permanent current assets. In addition, the firm has $740,000 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%. The balance will be financed with short-term financing, which currently costs 5%. Lear’s earnings before interest and taxes are $340,000. Determine Lear’s earnings after taxes under this financing plan. The tax rate is 30%.
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 $340,000. What will be Lear's earnings after taxes? The tax rate is 30%.

See explanation

Explanation:

A. Current assets = permanent current assets + temporary current assets

Temporary current assets:

= $940,000 - $420,000

= $520,000

Short-term interest expense:

= 5% × [$520,000 + ½ ($420,000)]

= 5% ($520,000 + $210,000)

= 5% × ($730,000)

= 0.05 × $730,000

= $36,500

Long-term interest:

= 9% × [$740,000 + ½ ($420,000)]

= 9% × ($740,000 + $210,000)

= 9% × $950,000

= 0.09 × $950,000

= $85,500

Total interest expense:

= $36,500 + $85,500

= $122,000

Earnings before interest and taxes $340,000

Less: Interest expense = $122,000

Earnings before taxes = $218,000

Less: Taxes (30%) = $65,400

Earnings after taxes = $152,600

B. Short term interest expense:

= $260,000 × 5%

= $260,000 × 0.05

= $13,000

Long term interest expense:

= ($740,000 + $420,000 + $260,000) × 9%

= $1,420,000 × 0.09

= $127,800

Total interest expense:

= $13000 + $127800

= $140,800

Earnings before interest and taxes $340,000

Less: Interest expense = $140,800

Earnings before taxes = $199,200

Less: Taxes (30%) = $59760

Earnings after taxes = $139440

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