Guardian Inc. is trying to develop an asset-financing plan. The firm has $500,00
ID: 2615350 • Letter: G
Question
Guardian Inc. is trying to develop an asset-financing plan. The firm has $500,000 in temporary current assets and $400,000 in permanent current assets. Guardian also has $600,000 in fixed assets. Assume a tax rate of 30 percent.
a. Construct two alternative financing plans for Guardian. One of the plans should be conservative, with 80 percent of assets financed by long-term sources, and the other should be aggressive, with only 56.25 percent of assets financed by long-term sources. The current interest rate is 12 percent on long-term funds and 6 percent on short-term financing. Compute the annual interest payments under each plan.
Annual Interest
Conservative
Agrresive
b. Given that Guardian’s earnings before interest and taxes are $380,000, calculate earnings after taxes for each of your alternatives.
Earning After Taxes
Conservative
Aggresive
c. What would the annual interest and earnings after taxes for the conservative and aggressive strategies be if the short-term and long-term interest rates were reversed?
Conservative Agressive
Total Interest
Earning After taxes
Explanation / Answer
(a)
Temporary current assets = $500,000
Permanent current assets = $400,000
Fixed assets = $600,000
Total assets = 500,000 + 400,000 + 600,000
= $1,500,000
Under conservative plan, 80% of the assets will be financed by long term sources.
Hence, long term funds needed = 1,500,000 x 80%
= $1,200,000
Interest on long term funds = 1,200,000 x 12%
= $144,000
Hence, remaining funds will be arranged through short term sources = 1,500,000 - 1,200,000
= $300,000
Interest on short term funds = 300,000 x 6%
= $18,000
Hence annual interest payment = 144,000 + 18,000
= $162,000
Under aggressive plan, 56.25% of the assets will be financed by long term sources.
Hence, long term funds needed = 1,500,000 x 56.25%
= $843,750
Interest on long term funds = 843,750 x 12%
= $101,250
Hence, remaining funds will be arranged through short term sources = 1,500,000 - 843,750
= $656,250
Interest on short term funds = 656,250 x 6%
= $39,375
Hence annual interest payment = 101,250 + 39,375
= $140,625
(b)
(c)
Temporary current assets = $500,000
Permanent current assets = $400,000
Fixed assets = $600,000
Total assets = 500,000 + 400,000 + 600,000
= $1,500,000
Under conservative plan, 80% of the assets will be financed by long term sources.
Hence, long term funds needed = 1,500,000 x 80%
= $1,200,000
Interest on long term funds = 1,200,000 x 6%
= $72,000
Hence, remaining funds will be arranged through short term sources = 1,500,000 - 1,200,000
= $300,000
Interest on short term funds = 300,000 x 12%
= $36,000
Hence annual interest payment = 72,000 + 36,000
= $108,000
Under aggressive plan, 56.25% of the assets will be financed by long term sources.
Hence, long term funds needed = 1,500,000 x 56.25%
= $843,750
Interest on long term funds = 843,750 x 6%
= $50,625
Hence, remaining funds will be arranged through short term sources = 1,500,000 - 843,750
= $656,250
Interest on short term funds = 656,250 x 12%
= $78,750
Hence annual interest payment = 50,625 + 78,750
= $129,375
Annual interst Conservative $162,000 Aggresive $140,625Related Questions
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