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11.Colter Steel has $4,200,000 in assets.Temporary current

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  • "11.Colter Steel has $4,200,000 in assets.Temporary current assets ......................... $1,000,000Permanent current assets .......................... 2,000,000Fixed assets .............................................. 1,200,000 Total assets .....

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  • "11.Colter Steel has $4,200,000 in assets.Temporary current assets ......................... $1,000,000Permanent current assets .......................... 2,000,000Fixed assets .............................................. 1,200,000 Total assets ......................................... $4,200,000 Short-term rates are 8 percent. Long-term rates are 13 percent. Earnings before interest andtaxes are $996,000. 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? For agraphical example of perfectly matched plans, see Figure 6-5.6-11. Solution:Colter SteelLong-term financing equals: Permanent current assets $2,000,000 Fixed assets 1,200,000 $3,200,000Short-term financing equals: Temporary current assets $1,000,000Long-term interest expense = 13% × $3,200,000 = $ 416,000Short-term interest expense = 8% × 1,000,000 =80,000Total interest expense $ 496,000Earnings before interest and taxes $ 996,000 Interest expense496,000Earnings before taxes $ 500,000 Taxes (40%)200,000Earnings after taxes $ 300,000S6-14 12.In problem 11, assume the term structure of interest rates becomes inverted, with short- term rates going to 11 percent and long-term rates 4 percentage points lower than short- term rates.If all other factors in the problem remain unchanged, what will earnings after taxes be?6-12. Solution:Colter Steel (Continued)Long-term interest expense = 7% × $3,200,000 = $224,000Short-term interest expense = 11% × 1,000,000 = 110,000Total interest expense $334,000Earnings before interest and taxes $996,000 Interest expense 334,000Earnings before taxes $662,000 Taxes (40%) 264,800Earnings after taxes $397,200S6-15 13.Guardian, Inc., is trying to develop an asset-financing plan. The firm has $400,000 intemporary current assets and $300,000 in permanent current assets. Guardian also has$500,000 in fixed assets. Assume a tax rate of 40 percent.a. Construct two alternative financing plans for Guardian. One of the plans should beconservative, with 75 percent of assets financed by long-term sources, and the othershould be aggressive, with only 56.25 percent of assets financed by long-term sources.The current interest rate is 15 percent on long-term funds and 10 percent on short-termfinancing.b. Given that Guardian’s earnings before interest and taxes are $200,000, calculateearnings after taxes for each of your alternatives.c. What would happen if the short-and long-term rates were reversed?6-13. Solution:Guardian, Inc.a. Temporary current assets $ 400,000 Permanent current assets 300,000 Fixed assets500,000 Total assets $1,200,000Conservative % of Interest InterestAmount TotalRate Expense$1,200,000 × .75 = $900,000 ×.15 = $135,000 Long-term$1,200,000 × .25 = $300,000 ×.10 = 30,000 Short-term Total interest charge $165,000Aggressive$1,200,000 × .5625 = $675,000 × .15 = $101,250 Long-term$1,200,000 × .4375 = $525,000 × .10 = 52,500 Short-termTotal interest charge $153,750S6-16 6-13. (Continued)b. Conservative AggressiveEBIT $200,000 $200,000–Int 165,000 153,750EBT 35,000 46,250Tax 40%14,00018,500EAT $ 21,000 $ 27,750c. Reversed:Conservative$1,200,000 × .75 = $900,000 ×.10 = $ 90,000 Long-term$1,200,000 × .25 = $300,000 ×.15 =45,000 Short-term Total interest charge $135,000Aggressive$1,200,000 × .5625 = $675,000 ×.10 =$67,500 Long-term$1,200,000 × .4375 = $525,000 ×.15 =78,750 Short-term Total interest charge $146,250Reversed Conservative AggressiveEBIT $200,000 $200,000–Int 135,000 146,250EBT 65,000 53,750Tax 40%26,000 21,500EAT $ 39,000 $ 32,250S6-17 14.Lear, Inc., has $800,000 in current assets, $350,000 of which are considered permanentcurrent assets. In addition, the firm has $600,000 invested in fixed assets.a. Lear wishes to finance all fixed assets and half of its permanent current assets withlong-term financing costing 10 percent. Short-term financing currently costs 5 percent.Lear’s earnings before interest and taxes are $200,000. Determine Lear’s earnings aftertaxes under this financing plan. The tax rate is 30 percent.b. As an alternative, Lear might wish to finance all fixed assets and permanent currentassets plus half of its temporary current assets with long-term financing. The sameinterest rates apply as in part a. Earnings before interest and taxes will be $200,000.What will be Lear’s earnings after taxes? The tax rate is 30 percent.c. What are some of the risks and cost considerations associated with each of thesealternative financing strategies?6-14. Solution:Lear, Inc.a. Current assets – permanent current assets = temporary current assets$800,000–$350,000=$450,000Short-term interest expense = 5% [$450,000 + ½ ($350,000)] = 5% ($625,000) = $31,250Long-term interest expense = 10% [$600,000 + ½($350,000)] = 10% ($775,000) = $77,500Total interest expense = $31,250 + $77,500 = $108,750Earnings before interest and taxes $200,000 Interest expense108,750Earnings before taxes $91,250 Taxes (30%)27,375Earnings after taxes $ 63,875S6-18 "

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