Question

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 relaxed policy they will be 20% of sales. What is the difference in the projected ROEs between the restricted and relaxed policies?

.

4.3%

b.	5.3%
c.	4.7%

d.

6.67

Answer 1

	Restricted	Relaxed
Fixed Assets	100,000	100,000
Current Assets	40,000	80,000
Total Assets	140,000	180,000
Debt	70,000	90,000
Equity	70,000	90,000
Sales	400,000	400,000
EBIT	35,000	35,000
Less: Interest	7,000	9,000
EBT	28,000	26,000
Less: Taxes	11,200	10,400
Net Income	16,800	15,600
Equity	70,000	90,000
ROE	24.00%	17.33%
Difference in ROE	6.67%
Hence, the answer is d.