Chapter 6, Problem 14P

Guardian Inc. is trying to develop an asset financing plan. The firm has $\text{\$400,000}$ in temporary current assets and $\text{\$300,000}$ in permanent current assets. Guardian also has $\text{\$500,000}$ 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 75 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.

b. Given that Guardian’s earnings before interest and taxes are $\text{\$200,000}$ , calculate earnings after taxes for each of your alternatives.

c. What would happen if the short- and long-term rates were reversed?