3. (20 points, 4 points for each part) A firm has a financial objective of keepi

Question

3. (20 points, 4 points for each part) A firm has a financial objective of keeping its debt to equity ratio constant. (Debt, in this context, is defined as total current liabilities plus total long-term debt). Firm made a loss in year 2017 and did not sell any new stocks or any of its fixed assets during 2017. 5 financial analysts made the following assessments about the company upon obtaining this news. Please consider each one in turn, write a few sentences as to why you agree or disagree with their assessment.

Analyst #1: Short term debt will rise.

Analyst #2: Long term debt will rise.

Analyst #3: Either short or long-term debt or both will rise.

Analyst #4: Net working capital will fall.

Analyst #5: Equity will rise.

Explanation / Answer

Analyst 1# Short term debt will rise Agree with the assessment If company has cash credit or overdraft to run their day to day affairs, Short term debt may rise Analyst 2# Long term debt will rise Agree with the assessment If Company has taken new long term debt during the year to run their day to day affairs, the long term debt may rise. Analyst 3# Either short term or long term debt or both will rise Agree with the assessment This is due to reasons mentioned in the above two assessment Analyst 4# Net working capital will fall. Agree with the assessment Net working capital will fall when either current assets like cash has decreased or current liabilities like overdraft or cash credit has increased. So there is definate chance of falling net working capital Analyst 5# Equity will rise Disagree with assessment Since company did not sell any new stocks, The equity will infact fall due to loss absorption by retained eanrings.

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