1. Sherlock Homes, a manufacturer of low-cost mobile housing, has $4,500,000 in assets. .... Temporary current assets.... Permanent current assets... Capital assets ... Total assets ... $1,000,000 1,500,000 2,000,000 $4,500,000 Short-term rates are 8 percent. Long-term rates are 13 percent. (Note that long-term rates imply a return to any equity). Earnings before interest and taxes are $960,000. The tax rate is 40 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? For an example of perfectly hedged plans, see Figure 6-8. EDWARDS CORPORATION Plan A Earnings before interest and taxes. $200,000 Interest (short-term): 6% x $500,000 -30,000 Interest (long-term): 10% x $100,000. --10,000 Earnings before taxes 160,000 Taxes (50%) 80,000 Earnings after taxes. $ 80,000 Plan B Earnings before interest and taxes. $200,000 Interest (short-term): 6% x $150,000 -9,000 Interest (long-term): 10% x $450,000. -45,000 Earnings before taxes 146,000 Taxes (50%)... 73,000 Earnings after taxes $ 73,000 Note: Long-term financing could also be in the form of equity, Equity financing does not have an explicit cost on the income statement, but would impact earnings per share. Table 6-8 Impact of financing plans on earnings