Guardian Inc. is trying to develop an asset-financing plan. The firm has $410,00

Question

Guardian Inc. is trying to develop an asset-financing plan. The firm has $410,000 in temporary current assets and $310,000 in permanent current assets. Guardian also has $510,000 in fixed assets. Assume a tax rate of 30 percent. (Do not round intermediate calculations. Round your answers to the nearest whole number.)

Construct two alternative financing plans for Guardian. One of the plans should be conservative, with 70 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 16 percent on long-term funds and 8 percent on short-term financing. Compute the annual interest payments under each plan.

Given that Guardian’s earnings before interest and taxes are $290,000, calculate earnings after taxes for each of your alternatives.

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?

Guardian Inc. is trying to develop an asset-financing plan. The firm has $410,000 in temporary current assets and $310,000 in permanent current assets. Guardian also has $510,000 in fixed assets. Assume a tax rate of 30 percent. (Do not round intermediate calculations. Round your answers to the nearest whole number.)

Explanation / Answer

Part A

A-1)Conservative plan

Interest cost = total asset x % finance (long) x rate (long) + = total asset x % finance (short) x rate (short)

                          = 510,000 x 70% x 16% + 510,000 x30%x 8%

                          = 57,120 + 12,240

                          = 69,360

A-2) Aggressive plan

Interest cost = total asset x % finance (long) x rate (long) + = total asset x % finance (short) x rate (short)

                          = 510,000 x 56.25% x 16% + 510,000 x43.75%x 8%

                          = 45900 + 17850

                          = 63,750

Part B

Earnings after taxes = (EBIT – interest) x (1-tax rate)

B-1)Conservative plan

Earnings after taxes = (290,000 -69,360) x (1-0.30)

                                        = 220,640 x 0.70

                                        = 154,448

B-2) Aggressive plan

Earnings after taxes = (290,000 -63750) x (1-0.30)

                                        = 226,250 x 0.70

                                        = 158,375

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