Current assets investment policy Rentz Corporation is investigating the optimal

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 45% debt-to-assets ratio. Rentz's interest rate is currently 10% 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 12% 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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