Question

b) Christie Corporation is deciding whether to pursue a relaxed or restricted working capital investment policy. The firm’s annual sales are expected to be $4,800,000, its debt and common equity are each 50% of total assets. EBIT is $150,000, the interest rate on the firm‘s debt is 8%. If the company follows a restricted policy, its total assets turnover will be 2.5. Under a relaxed policy its total assets turnover will be 2.2. If the firm adopts a restricted policy, how much lower would its interest expense be than under the relaxed policy?

Answer 1

Computation of Interest
	Particulars	Restricted	Relaxed
A	Sales	$       4,800,000	$       4,800,000
B	Assets Turnover	2.50	2.20
C=A/B	Total Assets	$       1,920,000	$       2,181,818
D	Debt/Equity	50%	50%
E	Debt	$          960,000	$       1,090,909
F=Ex D	Interest @ 8%	$            76,800	$            87,273

If Company adopts restricted policy then it would incur $10,473( i.e $82,273-$76,800) interest lower than Relaxed policy