a.Rentz Corporation is investigating the optimal level of current assets for the coming year. Management expects sales to increase to approximately $3 million as a result of an asset expansion presently being undertaken. Fixed assets total $2 millin, and the frims plans to maintain a 60% debt-to-assets ratio. Rentz’s interest rate is currently 10% on both short-term and long-term debt ( which the firm uses in its permananet structure). Three alternative regarding the projected current assets level are under considerations: (1) a restricted policy where current assets would be only 45%of projected sales, (2) a moderate policy where current assets would be 50% sales, and (3) a relaxed policy where current assets would be 60% of sales. Earnings before interst and taxes should be 13% of total sales, and the federal-plus-state tax rate is 40%
a. What is the expected return on the equity under each current assets level?Round to two decimals.
Restricted policy __________%
Moderate policy __________%
Relaxed Policy ___________%
b. In this problem, we assume that expected sales re independent of the current asses investement policy. Is this a valid assumption? Choose one
a. Yes, this assumption would probably be valid in a real world situatio. A firms current asset plicies have no significant effect on sales.
b. Yes, sales are controlled only by the degree of marketing effort the firm uses, irrespective of the current asset policies it employs.
c. Yes, the current asset ploices followed by the firm mainly influecne the level of long-term debt used by the firm.
d. Yes, the current asset policies followed by the firm mainly influence the level of fixed assets.
e. No, this assumption would propbably be valid in a real world situation. A firms current asset policesmay have a significant effect on sales.
How would the firms risk be affected by the different policies?
|Restricted policy||Moderate policy||Relaxed policy|
|Earnings before taxes||$189,000.00||$180,000.00||$162,000.00|
|e. No, this assumption would probably be valid in a real world situation. A firms current asset polices may have a significant effect on sales.|
|Different policies affect in different way like restricted policy would increase expected return as the current assets level increases fund blocked in accounts receivable also increases and cost of bad debt also increases. Higher inventories results in reduced stock out and increase the goodwill.|