Hardwig Inc. is considering whether to pursue a restricted or relaxed current as

Question

Hardwig Inc. is considering whether to pursue a restricted or relaxed current asset investment policy. The firm's annual sales are expected to total $3,600,000, 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.

If the firm adopts a restricted policy, how much lower would its interest expense be than under the relaxed policy?

$9,818

$8,418

$10,309

$8,861

$9,327

What are the expected ROEs under the restricted and relaxed policies, respectively?

8.3% and 10.8%, respectively.

5.0% and 6.5%, respectively.

6.5% and 5.0%, respectively.

7.6% and 8.8%, respectively.

10.8% and 8.3%, respectively.

$9,818

$8,418

$10,309

$8,861

$9,327

Explanation / Answer

Hardwig Inc. Details Amt $   Annual Sales              3,600,000 EBIT                 150,000 Under restricted Policy Total Assets Turnover                        2.50 Total Assets =Sales/2.5 =              1,440,000 Debt: Equity =50:50 Equity                 720,000 Debt=                 720,000 EBIT                 150,000 Less : Interest on debt @10%                    72,000 EBT                    78,000 Tax @40%                    31,200 Net Profit                    46,800 ROE= Net Profit/Equity 6.50% Under Relaxed Policy Total Assets Turnover                        2.20 Total Assets =Sales/2.2 =              1,636,364 Debt: Equity =50:50 Equity                 818,182 Debt=                 818,182 EBIT                 150,000 Less : Interest on debt @10%                    81,818 EBT                    68,182 Tax @40%                    27,273 Net Profit                    40,909 ROE= Net Profit/Equity 5.00% Under restricted policy Interest=                    72,000 Under relaxed policy Interest=                    81,818 Difference in interest                      9,818 So under restricted policy interest is lower by $9,818 Answer a. is correct ROE in Retsricted policy 6.50% ROE in realxed policy 5.00% Answer c. is correct

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