Alternative Financial Plans

Alternative Financial Plans
FIN/200

14.) Lear, Inc. has $800,000 in current assets, $350,000 of which are considered permanent current 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 with long-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 after taxes under this financing plan. The tax rate is 30 percent.
Fixed Assets=$600,000
Half Permanent Assets=$175,000
Temporary Assets=$450,000
Long term financing=10%
Short term financing=5%
Earnings before taxes=$200,000
Tax Rate=30%

Long Term Interest
(600,000+175,000)x0.10=77,500

Short Term Interest
(450,000+175,000)x0.05=31,250

Total interest
77,500+31,250=108,750

Earnings after interest
200,000-108,750=91,250

Earnings after taxes
91,250x0.30=27,375
91,250-27,375=$63,875

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. The same interest 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.
Fixed Assets=$600,000
Permanent Assets=$350,000
Half Temporary Assets=$225,000
Long term financing=10%
Short term financing=5%
Earnings before taxes=$200,000
Tax Rate=30%

Long Term Interest
(600,000+350,000+225,000)x0.10=117,500

Short Term interest
225,000x0.05=11,250

Total interest
117,500+11,250=128,750

Earnings after interest
200,000-128,750=71,250

Earnings after taxes
71,250x0.30=21,375
71,250-21,375=$49,875

c. What are some of the risks and cost considerations associated with each of these alternative financing strategies? The risks and considerations with both of these financing strategies are interest rates. With long-term