Question

In: Finance

Big Retailer (BR) follows a moderate current asset investment policy, but is now considering a change,...

Big Retailer (BR) follows a moderate current asset investment policy, but is now considering a change, perhaps to a restricted or maybe to a relaxed policy. BR’s annual sales are $1,400,000; its fixed assets are $950,000; its target capital structure calls for 40% debt and 60% equity; its EBIT is $500,000; the interest rate on debt is 8%; and its tax rate is 20%. With a restricted policy, current assets will be 20% of sales, while under a relaxed policy, current assets will be 35% of sales. What is the difference in the projected ROEs between the restricted and relaxed policies? Enter your answer rounded to two decimal places. Do not enter % in the answer box. For example, if your answer is 0.12345 or 12.345% then enter as 12.35 in the answer box.

Solutions

Expert Solution

Calculating ROE under restricted policy

Sales = $1400000, Fixed assets = $950000

Under restrictive policy, Current assets = 20% of sales = 20% x 1400000 = 280000

Total assets = Fixed Assets + Current Assets = 950000 + 280000 = 1230000

We know that Total assets = Total capital = 1230000

Debt = 40% of total capital = 40% x 1230000 = 492000

Equity = 60% of total capital = 60% x 1230000 = 738000

Interest on debt = Interest rate x debt = 8% x 492000 = 39360

Net income = (EBIT - Interest)(1-Tax rate) = (500000 - 39360)(1-20%) = 460640 x 80% = 365812

Return on Equity = Net income / Equity = 365812 / 738000 = 49.5680%

Calculating ROE under relaxed policy

Sales = $1400000, Fixed assets = $950000

Under relaxed policy, Current assets = 35% of sales = 35% x 1400000 = 490000

Total assets = Fixed Assets + Current Assets = 950000 + 490000 = 1440000

We know that Total assets = Total capital = 1440000

Debt = 40% of total capital = 40% x 1440000 = 576000

Equity = 60% of total capital = 60% x 1440000 = 864000

Interest on debt = Interest rate x debt = 8% x 576000 = 46080

Net income = (EBIT - Interest)(1-Tax rate) = (500000 - 46080)(1-20%) = 453920 x 80% = 363136

Return on Equity = Net income / Equity = 363136 / 864000 = 42.0296%

Difference between ROE of Restrictive and Relaxed policy = 49.5680% - 42.0296% = 7.5384% = 7.54% (rounded to two decimal places)

Answer: 7.54%

jeff jeffy answered 9 months ago
Next > < Previous

Related Solutions

Big Retailer (BR) follows a moderate current asset investment policy, but is now considering a change,...
Big Retailer (BR) follows a moderate current asset investment policy, but is now considering a change, perhaps to a restricted or maybe to a relaxed policy. BR’s annual sales are $1,400,000; its fixed assets are $950,000; its target capital structure calls for 40% debt and 60% equity; its EBIT is $500,000; the interest rate on debt is 8%; and its tax rate is 20%. With a restricted policy, current assets will be 20% of sales, while under a relaxed policy,...
Big Retailer (BR) follows a moderate current asset investment policy, but is now considering a change,...
Big Retailer (BR) follows a moderate current asset investment policy, but is now considering a change, perhaps to a restricted or maybe to a relaxed policy. BR’s annual sales are $1,400,000; its fixed assets are $950,000; its target capital structure calls for 40% debt and 60% equity; its EBIT is $550,000; the interest rate on debt is 8%; and its tax rate is 20%. With a restricted policy, current assets will be 20% of sales, while under a relaxed policy,...
Big Retailer (BR) follows a moderate current asset investment policy, but is now considering a change,...
Big Retailer (BR) follows a moderate current asset investment policy, but is now considering a change, perhaps to a restricted or maybe to a relaxed policy. BR’s annual sales are $1,400,000; its fixed assets are $950,000; its target capital structure calls for 40% debt and 60% equity; its EBIT is $650,000; the interest rate on debt is 8%; and its tax rate is 20%. With a restricted policy, current assets will be 20% of sales, while under a relaxed policy,...
Big Retailer (BR) follows a moderate current asset investment policy, but is now considering a change,...
Big Retailer (BR) follows a moderate current asset investment policy, but is now considering a change, perhaps to a restricted or maybe to a relaxed policy. BR’s annual sales are $1,400,000; its fixed assets are $950,000; its target capital structure calls for 40% debt and 60% equity; its EBIT is $450,000; the interest rate on debt is 8%; and its tax rate is 20%. With a restricted policy, current assets will be 20% of sales, while under a relaxed policy,...
10 Big Retailer (BR) follows a moderate current asset investment policy, but is now considering a...
10 Big Retailer (BR) follows a moderate current asset investment policy, but is now considering a change, perhaps to a restricted or maybe to a relaxed policy. BR’s annual sales are $1,400,000; its fixed assets are $950,000; its target capital structure calls for 40% debt and 60% equity; its EBIT is $550,000; the interest rate on debt is 8%; and its tax rate is 20%. With a restricted policy, current assets will be 20% of sales, while under a relaxed...
Excellence Corporation follows a moderate current asset investment policy, but it is now considering a change,...
Excellence Corporation follows a moderate current asset investment policy, but it is now considering a change, perhaps to a restricted or maybe to a relaxed policy. The firm’s annual sales are $500,000; its fixed assets are $180,000; its target capital structure calls for 40% debt and 60% equity; its EBIT is $64,000; the interest rate on its debt is 14%; and its tax rate is 40%. With a restricted policy, current assets will be 18% of sales, while under a...
Buchholz Corporation follows a moderate current asset investment policy, but is now considering a change, perhaps...
Buchholz Corporation follows a moderate current asset investment policy, but is now considering a change, perhaps to a restricted or maybe to a relaxed policy. The firm's annual sales are $400,000; its fixed assets are $100,000; its target capital structure calls for 50% debt and 50% equity; its EBIT is $50,000; the interest rate on debt is 8%; and its tax rate is 25%. With a restricted policy, current assets will be 15% of sales, while under a relaxed policy,...
Buchholz Corporation follows a moderate current asset investment policy, but is now considering a change, perhaps...
Buchholz Corporation follows a moderate current asset investment policy, but is now considering a change, perhaps to a restricted or maybe to a relaxed policy. The firm's annual sales are $400,000; its fixed assets are $100,000; its target capital structure calls for 50% debt and 50% equity; its EBIT is $40,000; the interest rate on debt is 8%; and its tax rate is 25%. With a restricted policy, current assets will be 15% of sales, while under a relaxed policy,...
Jasper Enterprises follows a moderate current asset investment policy, but it is now considering whether to...
Jasper Enterprises follows a moderate current asset investment policy, but it is now considering whether to shift to a restricted or perhaps to a relaxed policy. The firm’s annual sales are $400,000, its fixed assets are $100,000, its target capital structure calls for 50% debt and 50% equity, its EBIT is $35,000, the interest rate on its debt is 10%, and its tax rate is 40%. With a restricted policy, current assets will be 20% of sales, while under a...
Jasper Enterprises follows a moderate current asset investment policy, but it is now considering whether to...
Jasper Enterprises follows a moderate current asset investment policy, but it is now considering whether to shift to a restricted or perhaps to a relaxed policy. The firm’s annual sales are $400,000, its fixed assets are $100,000, its target capital structure calls for 50% debt and 50% equity, its EBIT is $35,000, the interest rate on its debt is 10%, and its tax rate is 40%. With a restricted policy, current assets will be 10% of sales, while under a...
ADVERTISEMENT
Subjects
ADVERTISEMENT
Latest Questions
ADVERTISEMENT