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 $2 million, and the firm plans to maintain a 40% debt-to-assets ratio. Rentz's interest rate is currently 10% 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 13% 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. 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.
   2. Yes, this assumption would probably be valid in a real world situation. A firm's current asset policies have no significant effect on sales.
   3. Yes, sales are controlled only by the degree of marketing effort the firm uses, irrespective of the current asset policies it employs.
   4. Yes, the current asset policies followed by the firm mainly influence the level of long-term debt used by the firm.
   5. Yes, the current asset policies followed by the firm mainly influence the level of fixed assets.
   SELECT=________
4. How would the firm's risk be affected by the different policies?
   
   The input in the box below will not be graded, but may be reviewed and considered by your instructor.

Answer 1

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- 2x BL BMA 258 260 WORKING CAPITAL APPROACH - Microsoft Excel (Product Activation Failed) File Home Insert Page Layout Formulas Data Review View Add-Ins % Cut Σ AutoSum : A Calibri 11AA = = = 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 & Find & Formatting as Table Styles Clear Filter Select Clipboard Font Alignment CD Number Styles Cells Editing BJ269 _ AW AX AY AZ BA BB BC BD BE BE BG BH BI BJ B K 255 SALES 2000000 100% 40% 60% 256 CURRENT ASSETS FIXED ASSETS TOTAL ASSETS DEBT EQUITY 257 RESTRICTED POLICY 900000 2000000 2900000 1160000 1740000 45% OF SALES 259 MODERATE POLICY 1000000 2000000 3000000 1200000 1800000 50% OF SALES 261 RELAXED POLICY 1200000 2000000 3200000 1280000 1920000 262 60% OF SALES 263 264 EBIT % of sales = rate of interest = 10% 265 260000 266 267 RESTRICTED MODERATE RELAXED 268 EBIT 260000 260000 260000 269 INTEREST 116000 120000 128000 (10% ON DEBT) 270 EBT 144000 140000 132000 271 TAX (40%) 57600 56000 52800 272 NET INCOME 86400 84000 79200 273 RETURN ON EQUITY 4.97% 4.67% 4.13% [NET INCOME/EQUITY] 274 275 NO, THIS ASSUMPTION WOULD PROBABLY NOT VALID AS CURRENT ASSET POLICIES DO HAVE SIGNIFICANT EFFECT ON SALES ™ Sheet1 Sheet2 Z SCORE insu pv fv cash opti LINE OF CREDIT eoq_miller CARD BANKER ACCEPTANC FACTOR SI DISC FOCAL WC REQUIRE Sheet30 I Rea ferences BOJ 120% 2. 9 * * O 13% K + ENG 23-11-2019

- 2x Find & Select BL BM WORKING CAPITAL APPROACH - Microsoft Excel (Product Activation Failed) File Home Insert Page Layout Formulas Data Review View Add-Ins % Cut Σ AutoSum : A Calibri 11AA = = = Dr Wrap Text General E Copy Fill Paste B I U B- A E = 5 st Fat Merge Merge & Center - Center $ $ -% % , .0 .00 . Conditional Format Format Painter Cell Insert Delete Format Sort & Formatting as Table Styles 2 Clear Filter Clipboard Font Alignment Number Styles Cells Editing BJ306 Fax AW AX AY A Z BA BB BC BD BE BF BG BH BI BJ B K 287 288 289 290 291 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 293 RELAXED POLICY WILL INCREASE SALES BUT WILL ALSO INCREASE BAD DEBT AND COLLECTION COSTS AND SO RISK INCREASES MODERATE POLICY IS LARGELY FOLLOWED BY MAJOR COMPANIES AS THEY FOLLOW HOW MARKET BEHAVES SO RISK IS MODERATE HERE 295 BUT IT STILL DEPENDS ON HOW COMPANY IS ABLE TO TACKLE THE SITUATION 296 297 298 299 300 301 294 302 303 304 305 306 307 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 D F B * * 10 ENG 23-11-2019