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ALTERNATIVE FINANCING PLAN

# ALTERNATIVE FINANCING PLAN - Lear Inc has \$800,000 in...

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Lear, Inc., has \$800,000 in current assets, \$350,000 of which are considered permanent current assets. In addition, the firm has \$600,000 invested in fixed assets. a. Lear wishes to finance all fixed assets and half of its permanent current assets with long-term financing costing 10 percent. Short-term financing currently costs 5 percent. Lear’s earnings before interest and taxes are \$200,000. Determine Lear’s earnings after taxes under this financing plan. The tax rate is 30 percent. Current assets – permanent = temporary \$800,000 – \$350,000 = \$450,000 Short-term interest expense = 5% [\$450,000 + ½ (\$350,000)] = 5% (\$625,000) = \$31,250 Long-term interest expense = 10% [\$600,000 + ½ (\$350,000)] = 10% (\$775,000) = \$77,500 Total interest expense = \$31,250 + \$77,500 = \$108,750 before interest and taxes \$200,000 Interest expense 108,750 EBT \$ 91,250 Taxes (30%) 27,375 after taxes \$ 63,875 b . As an alternative, Lear might wish to finance all fixed assets and permanent current assets plus half of its temporary current assets with long-term financing. The same interest rates apply as in part a. Earnings before interest and taxes will be \$200,000. What will be Lear’s earnings after taxes? The tax

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