Question

Guardian Inc. is trying to develop an asset-financing plan. The firm has $330,000 in temporary current assets and $230,000 in permanent current assets. Guardian also has $430,000 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 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 12 percent on long-term funds and 7 percent on short-term financing. Compute the annual interest payments under each plan. Annual Interest Conservative108,900 Aggressive97,144 b. Given that Guardian's earnings before interest and taxes are $210,000, calculate earnings after taxes for each of your alternatives Earning 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? Conservative Aggressive Total interest Earnings after taxes

Answer 1

Temporary current assets	330,000
Permanent current assets	230,000
Fixed Assets	430,000
Total Assets	990,000

a.

Conservative approach total interest
Long term interest [990,000 *80%* 12%]	95040
Short term interest [990,000*20%*7%]	13860
Total	108900

Aggressive approach total interest
Long term interest [990,000 *56.25%* 12%]	66825
Short term interest [990,000*43.75%*7%]	30319
Total	97144

b.

	Conservative	Aggressive
EBIT	210,000	210,000
Less: Interest	108900	97144
EBT	101,100	112,856
Less: Tax @ 40%	40440	45143
Earnings after tax	60,660	67,714

c.

Conservative approach total interest
Long term interest [990,000 *80%* 7%]	55440
Short term interest [990,000*20%*12%]	23760
Total	79200

Aggressive approach total interest
Long term interest [990,000 *56.25%* 7%]	38981.25
Short term interest [990,000*43.75%*12%]	51975
Total	90956

	Conservative	Aggressive
EBIT	210,000	210,000
Less:Interest	79200	90956
EBT	130,800	119,044
Less: Tax @ 40%	52320	47618
Earnings after tax	78,480	71,426