Guardian Inc. is trying to develop an asset-financing plan. The firm has $480,000 in temporary current assets and $380,000 in permanent current assets. Guardian also has $580,000 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 60 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 15 percent on long-term funds and 10 percent on short-term financing. Compute the annual interest payments under each plan.
b. Given that Guardian’s earnings before interest and taxes are $360,000, calculate earnings after taxes for each of your alternatives.
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?