Zorn Corporation is deciding whether to pursue a restricted or relaxed working c
ID: 2432001 • Letter: Z
Question
Zorn Corporation is deciding whether to pursue a restricted or relaxed working capital investment policy. The firm's annual sales are expected to total $4,400,000, its fixed assets turnover ratio equals 4.0, and its debt and common equity are each 50% of total assets, EBIT is $150,000, the interest rate on the firm's debt is 10%, and the tax rate is 40%. If the company follows a restricted policy, its total assets turnover will be 2.5. Under a relaxed policy its total assets turnover will be 2.2 What's the difference in the projected ROEs under the restricted and relaxed policies?Explanation / Answer
Annual sales = $4,400,000. Fixed assets turnover = 4. Thus 4 = 4,400,000/fixed assets
Or fixed assets = 4,400,000/4 = $1,100,000
In case of restricted policy: 2.5 = 4,400,000/total assets. Thus total assets = 4,400,000/2.5 = $1,760,000
In case of relaxed policy: 2.2 = 4,400,000/total assets. Thus total assets = 4,400,000/2.2 = $2,000,000
The balance sheet will now look like this:
Next step is to compute the net income and ROE:
Thus the answer is option "c" i.e. 1.23%
Restricted Relaxed Current assets 660,000.00 900,000.00 Fixed assets 1,100,000.00 1,100,000.00 Total assets 1,760,000.00 2,000,000.00 Debt 880,000.00 1,000,000.00 Equity 880,000.00 1,000,000.00 Total liability and equity 1,760,000.00 2,000,000.00Related Questions
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