Question

CURRENT ASSETS INVESTMENT POLICY

Rentz Corporation is investigating the optimal level of current assets for the coming year. Management expects sales to increase to approximately $2 million as a result of an asset expansion presently being undertaken. Fixed assets total $1 million, and the firm plans to maintain a 40% debt-to-assets ratio. Rentz's interest rate is currently 8% 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 14% of total sales, and the federal-plus-state tax rate is 40%.

1. 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		%

2. 
   
3. In this problem, we assume that expected sales are independent of the current assets investment policy. Is this a valid assumption?
   1. Yes, this assumption would probably be valid in a real world situation. A firm's current asset policies have no significant effect on sales.
   2. Yes, sales are controlled only by the degree of marketing effort the firm uses, irrespective of the current asset policies it employs.
   3. Yes, the current asset policies followed by the firm mainly influence the level of long-term debt used by the firm.
   4. Yes, the current asset policies followed by the firm mainly influence the level of fixed assets.
   5. 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.
   
   -Select-IIIIIIIVVItem 4
4. 
   
5. How would the firm's risk be affected by the different policies?
   
   
   

Answer 1

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

WORKING CAPITAL APPROACH - Microsoft Excel (Product Activation Failed) Review View Add-Ins File Home Insert Page Layout Formulas Data - 2x % Cut Σ AutoSum : A Dr General AA = = = A Wrap Text Merge Merge & Center - Center SF 4:0 .00 . Insert Delete Format $ -% % Number Conditional Format Formatting as Table Styles Cell Styles Fill 2 Clear Sort & Filter Editing Find & Select Alignment Cells Calibri 11 E Copy Paste Format Painter B I U B- Clipboard Font BL266 - fic AW AX AY 255 SALES 2000000 256 RESTRICTED POLICY AZ BA BB BC BD BE BF BH BJ BL BM BG 100% TOTAL ASSETS 1900000 BI 40% DEBT 760000 B K 60% EQUITY 1140000 FIXED ASSETS 1000000 257 258 MODERATE POLICY CURRENT ASSETS 900000 45% OF SALES 1000000 50% OF SALES 1200000 60% OF SALES 1000000 2000000 800000 1200000 RELAXED POLICY 1000000 2200000 880000 1320000 EBIT % of sales = rate of interest = 8% 14% 280000 259 260 261 262 263 264 265 266 267 268 269 270 271 272 273 274 275 ™ Rea EBIT INTEREST EBT TAX (40%) NET INCOME RETURN ON EQUITY RESTRICTED 280000 60800 219200 87680 131520 11.54% MODERATE 280000 64000 216000 86400 129600 10.80% RELAXED 280000 70400 (8% ON DEBT) 209600 83840 125760 9.53% [NET INCOME/EQUITY] K Sheet1 Sheet2 ferences NO, THIS ASSUMPTION WOULD PROBABLY NOT VALID AS CURRENT ASSET POLICIES DO HAVE SIGNIFICANT EFFECT ON SALES Z SCORE insu pv fv cash opti LINE OF CREDIT eoq_miller CARD BANKER ACCEPTANC FACTOR SI DISC FOCAL WC REQUIRE Sheet30 I BOJ 120% D. 9 * 10 ENG 1a e 9 . + 03:06 25-11-2019

- 2x % Cut Find & Select BL BM WORKING CAPITAL APPROACH - Microsoft Excel (Product Activation Failed) File Home Insert Page Layout Formulas Data Review View Add-Ins Σ AutoSum : A Calibri 11 AA = = = Dr Wrap Text General E Copy Fill Paste B I U B- SF A Merge Merge & Center - Center Format Painter $ -% % 4:0 .00 . Conditional Format Cell Insert Delete Format Sort & Formatting as Table Styles 2 Clear Filter Clipboard Font Alignment CD Number Styles Cells Editing BL307 Fax AW AX AY A Z BA BB BC BD BE BF BG BH BI BJ B K 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 fv Sheet1 Sheet2 ferences cash opti LINE OF CREDIT eoq_miller CARD BANKER ACCEPTANC FACTOR SI DISC FOCAL WC REQUIRE Sheet3 | 201 120% | Rea 0 9 . * 10 ENG 25-11-2019