Payne slase last year were anemic $1.6 million, but with improved product mix it
ID: 2760471 • Letter: P
Question
Payne slase last year were anemic $1.6 million, but with improved product mix it expects to grow 25% this year. Fixed asses $1,000,000. Debt ratio 60%. Debt interest rate 8%. Policies: tight 45% of project sales, moderate 50% of sales tight up in current assets, relaxed 60% current assets saaless. Earnings before interest and taxes is expected to be 12 % of sales. Tax Rate 40%.
1. What is the expected return on equity under each current asset level?
2. The leel of expected sales is independent of current asset policy. Is this valid assumption? Why or why not?
3. How would the overall riskness of the firm vary under each policy?
Explanation / Answer
Project sales = 1.6 mn *1.25= $2 Mn
Fixed Assets = $ 1mn
Current Asset
Scenario 1 = .45*2 = $0.9 Mn
Scenario 2 =$1 Mn
Sceanrio 3 = $1.2 Mn
Total Assets
Scenario 1 = 1.9
Scenario 2 =$2 Mn
Sceanrio 3 = $2.2 Mn
Debt ratio = 60%
Which means equity ratio is 40% of total Assets
EBIT = .12*2 =$ .24 Mn
Return on Equity in Three scenraios
2. No this assumption is not valid because expected sales determine current assets as the amount of revieables will be determined by sales
3.Higher the current assets more risl for the firm because you are being leneient in giving more days for your cutomer to pay back.Policy which back fire you if customers dont pay
Scenario 1 Scenario 1 Scenario 3 EBIT 0.24 0.24 0.24 Asset size 1.9 2 2.2 Debt 1.14 1.2 1.32 Interest 0.09 0.10 0.11 EBIT - interest 0.15 0.14 0.13 Tax 0.06 0.06 0.05 PAT 0.09 0.09 0.08 Equity 0.76 0.8 0.88 PAT/Equity 11.75% 10.80% 9.16%Related Questions
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