Question

Big Retailer (BR) follows a moderate current asset investment policy, but is now considering a change, perhaps to a restricted or maybe to a relaxed policy. BR’s annual sales are $1,400,000; its fixed assets are $950,000; its target capital structure calls for 40% debt and 60% equity; its EBIT is $650,000; the interest rate on debt is 8%; and its tax rate is 20%. With a restricted policy, current assets will be 20% of sales, while under a relaxed policy, current assets will be 35% of sales. What is the difference in the projected ROEs between the restricted and relaxed policies? Enter your answer rounded to two decimal places. Do not enter % in the answer box. For example, if your answer is 0.12345 or 12.345% then enter as 12.35 in the answer box.

Answer 1

Answes Given that annual Sale 5 51400) 0ο Ο are ixed aSSetS abe 950000 debt 401 equity E BIT 6501000 The intede Yate on debt s 8 tax yate twith estricted Policy, Cubent assets wil be 27. as set s w be 35-/. undes olaxed policy, cubent Hee undes stncted po cy, Cuent asset5= do7. of Sales o. X 400,0 0o 80/000

aSset s Tetal asset 9 = Fxed a5set 5 cunt 9501000- R 80,000 2301000 Rmow that Tetal a5set S = Total Capita= 12301000 Dobt =40 of total aapital hol.X 12301000 49a/000 Equity=601. of fotal Capital = bo1.x1230,000 = 738 o00 Tntesest on debt =nteseyt ate x de bt -8.X49200o 39360 CEBIT Inte de t C- tax Yate). NOl in (o me = - 93 60) (-20%) 6 501000 -3 6101640x 80f

Net imome there fore, etubn euity equity 4881512 738000 NOW undes elaxed policy a6set =35 of. Sae535. x(40 00 0o CUent 490,000 To tal as5et 5 EFiXed asSets4 cureYt asset s 95000 0t49000 0 k401000 Know that Total aSsets z otal aptas 1440000 De bt = 4o y. Of to tal pit as 4o xl4hooco 576000

e to tal cap,E cl = 601. X 1440000 Euty=601 864000 Ysxazu i debt Intede tbte x dobt = 4 6080 CEB.ITintere Y (- Tax Yate) (6501000 -46030) (-20.) 603, 920 X80 - 483,136 Retaon equi by Ket inco meequit 483/136/86h000 55.918 51 ResAn'chue elaxed Policy inally,piheren Le between ROE 55.91851. 66.194031