Guardian Inc. is trying to develop an asset-financing plan. The firm has $510,00
ID: 2818190 • Letter: G
Question
Guardian Inc. is trying to develop an asset-financing plan. The firm has $510,000 in temporary current assets and $410,000 in permanent current assets. Guardian also has $610,000 in fixed assets. Assume a tax rate of 40 percent.
a. Construct two alternative financing plans for Guardian. One of the plans should be conservative, with 90 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 8 percent on short-term financing. Compute the annual interest payments under each plan.
b. Given that Guardian’s earnings before interest and taxes are $390,000, calculate earnings after taxes for each of your alternatives.
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?
Explanation / Answer
temporary current asset
510000
permanent current asset
410000
fixed assets
610000
total assets
1530000
conservative plan-90% assets with long term finance and 10% with short term finance
Amount of interest
assets financed from long term = 1530000*90%
1377000
1377000*12%
165240
assets financed from short term = 1530000*10%
153000
153000*8%
12240
total interest expense under conservative plan
177480
other plan-56.25% assets with long term finance and 43.75% with short term finance
Amount of interest
assets financed from long term = 1530000*90%
1530000*56.25%
860625
860625*12%
103275
assets financed from short term = 1530000*10%
1530000*43.75%
669375
669375*8%
53550
total interest expense under conservative plan
156825
Conservative plan
Other plan
B-
EBIT
390000
390000
less interest
177480
156825
EBT
212520
233175
less taxes-40%
85008
93270
EAT
127512
139905
C-
conservative plan-90% assets with long term finance and 10% with short term finance
Amount of interest
assets financed from long term = 1530000*90%
1530000*90%
1377000
1377000*8%
110160
assets financed from short term = 1530000*10%
1530000*10%
153000
153000*12%
18360
total interest expense under conservative plan
128520
other plan-56.25% assets with long term finance and 43.75% with short term finance
Amount of interest
assets financed from long term = 1530000*90%
1530000*56.25%
860625
860625*8%
68850
assets financed from short term = 1530000*10%
1530000*43.75%
669375
669375*12%
80325
total interest expense under conservative plan
149175
Conservative plan
Other plan
EBIT
390000
390000
less interest
128520
149175
EBT
261480
240825
less taxes-40%
104592
96330
EAT
156888
144495
temporary current asset
510000
permanent current asset
410000
fixed assets
610000
total assets
1530000
conservative plan-90% assets with long term finance and 10% with short term finance
Amount of interest
assets financed from long term = 1530000*90%
1377000
1377000*12%
165240
assets financed from short term = 1530000*10%
153000
153000*8%
12240
total interest expense under conservative plan
177480
other plan-56.25% assets with long term finance and 43.75% with short term finance
Amount of interest
assets financed from long term = 1530000*90%
1530000*56.25%
860625
860625*12%
103275
assets financed from short term = 1530000*10%
1530000*43.75%
669375
669375*8%
53550
total interest expense under conservative plan
156825
Conservative plan
Other plan
B-
EBIT
390000
390000
less interest
177480
156825
EBT
212520
233175
less taxes-40%
85008
93270
EAT
127512
139905
C-
conservative plan-90% assets with long term finance and 10% with short term finance
Amount of interest
assets financed from long term = 1530000*90%
1530000*90%
1377000
1377000*8%
110160
assets financed from short term = 1530000*10%
1530000*10%
153000
153000*12%
18360
total interest expense under conservative plan
128520
other plan-56.25% assets with long term finance and 43.75% with short term finance
Amount of interest
assets financed from long term = 1530000*90%
1530000*56.25%
860625
860625*8%
68850
assets financed from short term = 1530000*10%
1530000*43.75%
669375
669375*12%
80325
total interest expense under conservative plan
149175
Conservative plan
Other plan
EBIT
390000
390000
less interest
128520
149175
EBT
261480
240825
less taxes-40%
104592
96330
EAT
156888
144495
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