Current assets investment policy Rentz Corporation is investigating the optimal
ID: 2638684 • Letter: C
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 $3 million, and the firm plans to maintain a 55% debt-to-assets ratio. Rentz's interest rate is currently 9% on both short-term and longer-term debt (which the firm uses in its permanent structure). Three alternatives regarding the projected current asset 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%.
What is the expected return on equity under each current asset level? Round your answers to two decimal places.
Restricted policy % Moderate policy % Relaxed policy %Explanation / Answer
Current Assets of TightPolicy ($2,000,000 * 45%) = $900,000
Current Assets of Moderate Policy($2,000,000 * 50%) = $1,000,000
Current Assets of Relaxed Policy($2,000,000 * 60%) = $1,200,000
Tight Policy
Moderate Policy
Relaxed Policy
Current Assets $900,000 $1,000,000 $1,200,000
Fixed Assets $1,000,000 $1,000,000 $1,000,000
Total Assets $1,900,000 $2,000,000 $2,200,000
Debt ratio (60% on Total Assets) $1,140,000 $1,200,000 $1,320,000
Equity $760,000 $800,000 $880,000
Total Debt + Equity $1,900,000 $2,000,000 $2,200,000
EBIT(12% on $2,000,000) $240,000 $240,000 $240,000
Interst on both short & Longterm debt (8%) $91,200 $96,000 $105,600
Earning Before Tax $148,800 $144,000 $134,400
Tax (40%) $59,520 $57,600 $53,760
Net Income $89,820 $86,400 $80,640
Return on Equity (ROE) 11.82% 10.80% 9.16%
Return on Equity (ROE) = Net Income /Shareholder's Equity
(b) No it is not a valid assumption.Why because firms current assets policy like Accounts receivables,collection periods,
and discounts will have a significantimpact on sales.
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