Share
Explore BrainMass

A firm needs \$1 million in additional funds. What will be the firm's earnings under each alternative if earnings before interest and taxes (EBIT) are \$430,000? Why do earnings tend to fluctuate more with the use of short-term debt than with long-term debt?

1. A firm needs \$1 million in additional funds. These can be borrowed from a commercial bank with a loan at 6 percent for one year or from an insurance company at 9 percent for five years. The tax rate is 30 percent.
A. What will be the firm's earnings under each alternative if earnings before interest and taxes (EBIT) are \$430,000?
B. If EBIT will remain \$430,000 next year, what will be the firm's earnings under each alternative if short-term interest rates are 4 percent? If short-term interest rates are 14 percent?
C. Why do earnings tend to fluctuate more with the use of short-term debt than with long-term debt? If long-term debt had a variable interest rate that fluctuated with changes in interest rates, would the use of short-term debt still be riskier than long-term debt?

2. Annual sales in units 30,000
Cost of placing an order \$60.00
Per-unit carrying costs \$1.50
Existing units of safety stock 300

A. What is the EOQ
B. What is the average inventory based on the EOQ and the existing safety stock?
C. What is the maximum level of inventory?
D. How many orders are placed each year?

Solution Preview

1. A firm needs \$1 million in additional funds. These can be borrowed from a commercial bank with a loan at 6 percent for one year or from an insurance company at 9 percent for five years. The tax rate is 30 percent.
A. What will be the firm's earnings under each alternative if earnings before interest and taxes (EBIT) are \$430,000?
Plan A Plan B
EBIT 430000 430000
Interest 60000 90000
EBT 370000 340000
Tax @30% 111000 102000
Earnings after tax 259000 238000

B. If EBIT will remain \$430,000 next year, what will be the firm's earnings under each alternative if short-term interest rates are 4 percent? If short-term interest rates are 14 percent?
State 1: Short term interest rate ...

Solution Summary

You will find the answer to this puzzling assignment inside...

\$2.19