Current Asset Usage Policy Payne Products had $1.6 million in sales revenues in
ID: 2795063 • Letter: C
Question
Current Asset Usage Policy
Payne Products had $1.6 million in sales revenues in the most recent year and expects sales growth to be 25% this year. Payne would like to determine the effect of various current assets policies on its financial performance. Payne has $3 million of fixed assets and intends to keep its debt ratio at its historical level of 60%. Payne's debt interest rate is currently 9%. You are to evaluate three different current asset policies: (1) a restricted policy in which current assets are 45% of projected sales, (2) a moderate policy with 50% of sales tied up in current assets, and (3) a relaxed policy requiring current assets of 60% of sales. Earnings before interest and taxes are expected to be 13% of sales. Payne's tax rate is 40%.
What is the expected return on equity under each current asset level? Round your answers to two decimal places.
In this problem, we have assumed that the level of expected sales is independent of current asset policy. Is this a valid assumption?
I. The current asset policies followed by the firm mainly influence the level of long-term debt used by the firm.
II. The current asset policies followed by the firm mainly influence the level of fixed assets.
III. Yes, this assumption would probably be valid in a real world situation. A firm's current asset policies have no significant effect on sales.
IV. Sales are controlled only by the degree of marketing effort the firm uses, irrespective of the current asset policies it employs.
V. No, this assumption would probably not be valid in a real world situation. A firm's current asset policies may have a significant effect on sales.
-Select-IIIIIIIVVItem 4
Why or why not?
The input in the box below will not be graded, but may be reviewed and considered by your instructor.
How would the overall risk of the firm vary under each policy?
The input in the box below will not be graded, but may be reviewed and considered by your instructor.
Tight policy % Moderate policy % Relaxed policy %Explanation / Answer
Sales = 1.6*10^6 * ( 1+25%) = 2000000
EBIT = 13%* 2000000 = 260000
Fixed assets = 3000000
a)
tight policy
current assets = 45%*2000000 = 900000
Total assets = 3000000 + 900000 = 3900000
Debt = 60%*3900000 = 2340000
Equity = 3900000 - 2340000 = 1560000
PAT = (1-40%)*(2000000 - 9%*2340000) = 29640
ROE = 29640 / 1560000 = 1.9%
moderate policy
current assets = 50%*2000000 = 1000000
Total assets = 3000000 + 1000000 = 4000000
Debt = 60%*4000000 = 2400000
Equity = 4000000 - 2400000 = 1600000
PAT = (1-40%)*(2000000 - 9%*2400000) = 26400
ROE = 26400 / 1600000 = 1.65%
Relaxed policy
current assets = 60%*2000000 = 1200000
Total assets = 3000000 + 1200000 = 4200000
Debt = 60%*4200000 = 2520000
Equity = 4200000- 2520000 = 1680000
PAT = (1-40%)*(2000000 - 9%*2520000) = 19920
ROE = 19920 / 1680000 = 1.19%
b)
Option 4
Sales is depends on marketing
c)
As policy gets tightened it impacts ROE.
As current assets are increasing ROE decreases
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.