Colter Steel has $5,200,000 in assets. Assume the term structure of interest rat
ID: 2739117 • Letter: C
Question
Colter Steel has $5,200,000 in assets.
Assume the term structure of interest rates becomes inverted, with short-term rates going to 14 percent and long-term rates 5 percentage points lower than short-term rates. Earnings before interest and taxes are $1,100,000. The tax rate is 30 percent.
If long-term financing is perfectly matched (synchronized) with long-term asset needs, and the same is true of short-term financing, what will earnings after taxes be?
Temporary current assets $ 2,400,000 Permanent current assets 1,570,000 Fixed assets 1,230,000 Total assets $ 5,200,000
Explanation / Answer
Earnings before interest and taxes = $1,100,000
Short-term interest = Current assets × 14%
= (2,400,000 + 1,570,000) × 14%
= $555,800
Long-term interest = Fixed assets × (14 – 5) %
= 1,230,000 × 9%
= $110,700
Earnings after interest = $1,100,000 – ($555,800 + $110,700)
= $433,500
Earnings after taxes = Earnings after interest × (1 – tax rate)
= $433,500 × (1 – 0.30)
= $433,500 × 0.70
= $303,450