Stevens, Inc is developing an asset financing plan. Stevens has $1,000,000 in cu
ID: 2700628 • Letter: S
Question
Stevens, Inc is developing an asset financing plan. Stevens has $1,000,000 in current assets and $700,000 in fixed assets. The current long-term rate is 8%, and the current short-term rate is 6.5%. Steven's tax rate is 30%.
Construct two financing plans-one conservative, with 65% of assets financed by long-term sources, and the other aggressive, with only 30% of assets financed by long-term sources. If Steven's earnings before interest and taxes are $560,000, calculate net income under each alternative.
Explanation / Answer
Plan 1 (65% assest finance by long-term sources)
total investment =1700000
65% of assests = 0.65 * 1700000 = 1105000
interest amount = 1105000 * 0.08 = 88400
interest on 35% amount = (1700000-1105000) * 0.065 = 38675
total interest expense per year = 127075
plan 2 (30% assest financed by long term sources)
total investment =1700000
30% of assests = 0.30 * 1700000 = 510000
interest amount = 510000 * 0.08 = 40800
interest on 70% amount = (1700000-510000) * 0.065 = 77350
total interest expense per year = 118150
PLAN 1
income before interest = 560000
interest = 127075
income after inetrest = 432925
tax = 432925 * 0.30 = 129877.5
Net income = 303047.5
PLAN 2
income before interest = 560000
interest = 118150
income after inetrest = 441850
tax = 441850 * 0.30 = 132555
Net income = 309295
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