Question

Colter Steel has $4,750,000 in assets. Temporary current assets $ 1,500,000 Permanent current assets 1,525,000 Fixed assets 1,725,000 Total assets $ 4,750,000 Assume the term structure of interest rates becomes inverted, with short-term rates going to 14 percent and long-term rates 6 percentage points lower than short-term rates. Earnings before interest and taxes are $1,010,000. The tax rate is 30 percent. If long-term financing is perfectly matched (synchronized) with long-term asset needs, and the same is true of short-term financing, what will earnings after taxes be?

Answer 1

Answer:

$423,500

Explanation:

The computation of earnings after taxes is shown below:-

Interest cost = Long term rate × (Current assets + Fixed assets) + Short term rate × Temporary current assets

= 6% × ($1,525,000 + $1,725,000) + 14% × $1,500,000

= $405,000

So,

Earnings after taxes =  (Earnings before interest and taxes - Interest cost) × (1 - Tax rate)

= ($1,010,000 - $405,000) × (1 - 30%)

= $423,500

Hence, for determining the earnings after tax we simply applied the above formula.