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A company is considering different options with respect to the current asset policy. In all instances,...

A company is considering different options with respect to the current asset policy. In all instances, the firms fixed assets will be $1,000,000 and the firm plants to use of debt ration of 70% (D/TA = 0.7). The market interest rate is 9% on all debt used (both short and long term). Two options are under consideration: Option 1 - hold current assets equal to 30% of projected sales. Option 2 - hold current assets equal to 60% of projected sales. The company forecasts it will earn 25% of sales before paying interest (EBIT = 0.25 * Sales) and projects to do $3,000,000 in sales. Finally, the federal and state tax rate is 35%. What is the ROE for each option?

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Option 1 Option 2
Sales $    30,00,000 $    30,00,000
Fixed assets $    10,00,000 $    10,00,000
Current assets $      9,00,000 $    18,00,000
Total assets $    19,00,000 $    28,00,000
Debt [70% of total assets] $    13,30,000 $    19,60,000
Equity $      5,70,000 $       8,40,000
INCOME STATEMENT [PARTIAL] AND ROE
EBIT [3000000*25%] $      7,50,000 $       7,50,000
Interest at 9% on debt $      1,19,700 $       1,76,400
EBT $      6,30,300 $       5,73,600
Tax at 35% $      2,20,605 $       2,00,760
NI $      4,09,695 $       3,72,840
ROE [NI/Equity] 71.88% 44.39%

jeff jeffy answered 1 month ago
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