Question

Rentz Corporation is investigating the optimal level of current assets for the coming year. Management expects sales to increase to approximately $4 million as a result of an asset expansion presently being undertaken. Fixed assets total $2 million, and the firm plans to maintain a 60% debt-to-assets ratio. Rentz's interest rate is currently 9% on both short-term and long-term debt (which the firm uses in its permanent structure). Three alternatives regarding the projected current assets level are under consideration: (1) a restricted policy where current assets would be only 45% of projected sales, (2) a moderate policy where current assets would be 50% of sales, and (3) a relaxed policy where current assets would be 60% of sales. Earnings before interest and taxes should be 12% of total sales, and the federal-plus-state tax rate is 40%.

A.What is the expected return on equity under each current assets level? Round your answers to two decimal places.

Restricted policy

Moderate policy

Relaxed policy

B.In this problem, we assume that expected sales are independent of the current assets investment policy. Is this a valid assumption?

Yes, this assumption would probably be valid in a real world situation. A firm's current asset policies have no significant effect on sales.

Yes, sales are controlled only by the degree of marketing effort the firm uses, irrespective of the current asset policies it employs.

Yes, the current asset policies followed by the firm mainly influence the level of long-term debt used by the firm.

Yes, the current asset policies followed by the firm mainly influence the level of fixed assets.

No, this assumption would probably not be valid in a real world situation. A firm's current asset policies may have a significant effect on sales.

C.How would the firm's risk be affected by the different policies?

Answer 1

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WORKING CAPITAL APPROACH - Microsoft Excel (Product Activation Failed) Review View Add-Ins File Home Insert Page Layout Formulas Data - 2x % Cut AutoSum - A Calibri = = = Dr General 11AA A E Copy Paste Format Painter Clipboard Wrap Text Merge Merge & Center Center B I U - D SF 4:0 .00 8.9 Insert Delete Format $ - % % Number Conditional Format Formatting as Table Styles Cell Styles Fill 2 Clear Sort & Filter Editing Find & Select Font Alignment Cells BJ233 AW AZ BA BB BC BD BE BF AX SALES AY 4000000 BH BJ BL B 218 BG 100% TOTAL ASSETS 3800000 BI 60% DEBT 2280000 B K 60% EQUITY 1520000 219 FIXED ASSETS 2000000 RESTRICTED POLICY 220 221 222 MODERATE POLICY CURRENT ASSETS 1800000 45% OF SALES 2000000 50% OF SALES 2400000 60% OF SALES 2000000 4000000 2400000 1600000 223 224 RELAXED POLICY 2000000 4400000 2640000 1760000 225 226 227 EBIT % of sales = rate of interest = 9% 228 12% 480000 229 230 231 232 233 234 235 236 a 237 238 b ► Rea EBIT INTEREST EBT TAX (40%) NET INCOME RETURN ON EQUITY RESTRICTED 480000 205200 274800 109920 164880 10.85% MODERATE 480000 216000 264000 105600 158400 9.90% RELAXED 480000 237600 (9% ON DEBT) 242400 96960 145440 8.26% [NET INCOME/EQUITY] Sheet3 LAST ONE : NO, THIS ASSUMPTION IS NOT VALID AS CURRENT ASSET POLICIES DO HAVE SIGNIFICANT EFFECT ON SALES Sheet1 Sheet2 Z SCORE insu pv fv cash optiLINE OF CREDIT eog miller CARD BANKER ACCEPTANC FACTOR SI DISC FOCAL WC REQUIRE ferences 2. B T |BOJ 120% O 1 + 9 * R 40 ENG 30-11-2019

- 2x BL BA WORKING CAPITAL APPROACH - Microsoft Excel (Product Activation Failed) File Home Insert Page Layout Formulas Data Review View Add-Ins % Cut AutoSum - A Calibri 11AA = = = Dr Wrap Text General E Copy Fill Paste I B U B- Find & A Merge & Center - $ -% Sort & . Format Painter Formatting as Table Styles 2 Clear Filter Select Clipboard Font Alignment Number Styles Cells Editing BJ307 AW AX AY AZ BA BB BC BD BE BE BG BH BI BJ BK 288 289 290 291 EACH POLICY HAS ITS ADVANTAGES & DISADVANTAGES 292 RESTRICTED POLICY WILL REDUCE SALES BUT WILL ALSO REDUCE BAD DEBT AND OTHER COLLECTION EXPENSES AND SO RISK RELAXED POLICY WILL INCREASE SALES BUT WILL ALSO INCREASE BAD DEBT AND COLLECTION COSTS AND SO RISK INCREASES 294 MODERATE POLICY IS LARGELY FOLLOWED BY MAJOR COMPANIES AS THEY FOLLOW HOW MARKET BEHAVES SO RISK IS MODERATE HERE BUT IT STILL DEPENDS ON HOW COMPANY IS ABLE TO TACKLE THE SITUATION 296 297 298 293 295 299 300 301 302 303 304 305 306 307 308 Z SCORE insu pv fr cash opti LINE OF CREDIT og_miller CARD BANKER ACCEPTANC FACTOR SI DISC FOCAL WC REQUIRE Sheet1 Sheet2 ferences Rea Sheet30 I B0 9 0 + 2. 120% * 40 R ENG 30-11-2019