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A. Sherlock Homes, a manufacturer of low cost mobile housing, has $5,050,000 in assets.
Temporary current assets $2,100,000 Permanent current assets 1,555,000 Capital assets 1,395,000 Total assets $5,050,000
Short-term rates are 11 percent. Long-term rates are 16 percent. (Note that long‐term rates imply a return to any equity). Earnings before interest and taxes are $1,070,000. The tax rate is 30 percent.
If long-term financing is perfectly matched (hedged) with long-term asset needs, and the same is true of short-term financing, what will earnings after taxes be?
Earnings after taxes $ _________
B. Currently, Atlas Tours has $6.36 million in assets. This is a peak six-month period. During the other six months, temporary current assets drop to $520,000.
Temporary current assets$1,320,000 Permanent current assets 2,040,000 Capital assets 3,000,000 Total assets $6,360,000
Short-term rates are 4 percent. Long-term rates are 5 percent. Annual earnings before interest and taxes are $1,200,000. The tax rate is 38 percent.
1. If the assets are perfectly hedged throughout the year, what will earnings after taxes be? (Enter answers in whole dollar, not in million.)
Earnings after taxes $____________
2. If short-term interest rates increase to 5 percent when assets are at their lowest level, what will earnings after taxes be?
Earnings after taxes $ _________
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