Alternative Financing Checkpoint

Alternative financing plans

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 current assets with long-term financing costing 10%. Short-term financing currently costs 5%. Lear’s earnings before taxes and interest are $200,000. Determine Lear’s earnings after taxes under this financing plane. The tax rate is 30%.

175,000 + 600,000 = 775,000 x .10 = 77,500 (long-term interest)

175,000 + 450,000 = 625,000 x .05 = 31,250 (short-term interest)

77,500 + 31,250 = 108,750 (short and long-term interest)

200,000 – 108,750 = 91,250 (after interest)

91,250 x .30 = 27,375 (taxes owed)

91, 250 – 27,375 = 63,875 (net income)

B.) As an alternative, Lear might wish to finance all fixed assets and permanent current assets plus half of its temporary assets with long-term financing. The same rates apply as in part a. Earnings before taxes will be $200,000. What will Lear’s earnings be after taxes? The tax rate is 30%.

600,000 + 350,000 + 225,000 = 1,175,000

1,175,000 x .10 = 117,500(long-term interest)

225,000 x .05 = 11,250 (short-term interest)

117,500 + 11,250 = 128,750 (total interest)

200,000 – 128,750 = 71,250 (before taxes)

71,250 x .30 = 21,375 (taxes owed)

71,250 – 21,375= 49,875 (net income)

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

Some of the risks and considerations associated with these alternative financing strategies are that Long-term financing tends to be more expensive as opposed to short-term, costing the company more money and affecting its net income. But, it can be paid off over a longer period of time as opposed to short-term financing, which has paid off within a year of obtaining it. Long-term financing also gives you a more stable source for funding, where as short-term...