Accounting

Complete Problem 14 on p. 184 of Foundations of Financial Management.

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. 175,000(half of working capital)+600,000(fixed assets)=775,000 in assets to be financed with LT Debt (10% interest rate)

The other $175,000(half of permanent current) will be financed at 5% as well as the 450,000 in variable current assets. ($625,000x.05) The company has no equity! (It's an American bank)

EBIT: $200,000

LT EXPENSE $11750

ST EXPENSE $31250

EBT: $108,750

TAXES: (30%) $32525

NET INCOME: $76125

B. 225,000(half of variable current assets) +350,000(permanent current) +600,000(all fixed) =1175000 borrowed at 10%.

EBIT: $200,000

LT EXPENSES $117,500

ST EXPENSE $11,250

EBT: $71,250

TAX (30%) $21,325

NET INCOME: $49,875

C. What are some of the risks and cost considerations associated with each of these alternative financing strategies? 

The main parts of the risks include matching principle, long-term needs to be financed with long-term liabilities. The cost of long-term debt is greater, in case 10% vs 5%, provides for a stable funding source. Short-term debt only has a period of one year at its maximum, and then renewed. One problem that can be faced is difficulty in securing short-term loans when they are needed, Fixed and current assets are considered to be permanent known as capital needed to be financed with long-term debts is expensive and affects your bottom line.