Question

Times Inc. is trying to develop an asset-financing plan. The firm has $540,000 in temporary current assets and $440,000 in permanent current assets. Times also has $640,000 in fixed assets. Assume a tax rate of 40 percent. (Do not round intermediate calculations. Round your answers to the nearest whole number.) a. Construct two alternative financing plans for Times. 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 14 percent on long-term funds and 8 percent on short-term financing. Compute the annual interest payments under each plan. Annual Interest Conservative $ Aggressive $ b. Given that Times' earnings before interest and taxes are $420,000, calculate earnings after taxes for each of your alternatives. Earnings After Taxes Conservative $ Aggressive $ 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

Answer 1

Answer:

Times Inc.

                                                 Conservative         Aggressive

a) Annual interest payments        $207,360           $184,275

b) Earnings After Taxes                 $127,584           $141,475

c) Annual interest payments        $149,040           $172,125

Earnings After Taxes                    $162,576          $148,725

Explanation:

a) Data and Calculations:

Temporary current assets = $540,000

Permanent current assets =   440,000

Fixed assets =                         640,000

Total assets =                     $1,620,000

Assumed tax rate = 40%

                                                 Conservative         Aggressive

Financed by long-term sources       80%                    56.25%

Long-term finance                     $1,296,000              $911,250

Short-term finance                         324,000 (20%)     708,750 (43.75%)

Annual interest payments:

Long-term interest rate = 14%      $181,440              $127,575

Short-term interest rate = 8%         25,920                 56,700

Total annual interest payments $207,360              $184,275

b) Earnings before

 interest and taxes                   $420,000               $420,000

Annual interest payments          207,360                   184,275

Earnings before taxes               $212,640               $235,725

Income taxes (40%)                       85,056                   94,250

Earnings After Taxes                 $127,584                 $141,475

Annual interest payments:

Long-term interest rate = 8%      $103,680              $72,900

Short-term interest rate = 14%        45,360                99,225

Total annual interest payments  $149,040             $172,125

c) Earnings before

 interest and taxes                   $420,000               $420,000

Annual interest payments           149,040                    172,125

Earnings before taxes              $270,960                $247,875

Income taxes (40%)                     108,384                     99,150

Earnings After Taxes                $162,576                 $148,725