In: Finance
The Calgary Group of Companies (CGC) is attempting to establish a working capital policy. Fixed assets are R600 000 and the firm plans to maintain a 50% debt to total assets ratio. The interest rate is 10% on all debt. Three alternative current assets policies are under review 40% (aggressive policy), 50% (moderate policy) and 60% (conservative policy), all on the projected sales. The company expects to earn 15% before interest and taxes (EBIT) on sales of R3 000 000. CGC has a tax rate of 30%.
REQUIRED:
1.1 Determine the company's expected return on equity (ROE) under
each of the three alternative working capital policies above
HINT: Use the information provided above to complete the tables
provided below where indicated. Then, determine the expected ROE
for each of these alternative working capital policies. Use the
space provided below for your preliminary calculations.
Table 1: ALTERNATIVE BALANCE SHEETS FOR CALGARY GROUP OF COMPANIES
Aggressive policy (40%) (R) | Moderate policy (50%) (R) | Conservative policy (60%) (R) | |
Current assets | |||
Fixed assets | |||
Total assets | |||
Debt | |||
Equity | |||
Total equity and liabilities |
Table 2: ALTERNATIVE INCOME STATEMENTS FOR CALGARY GROUP OF COMPANIES
Aggressive policy (40%) | Moderate policy (50%) | Conservative policy (60%) | |
Sales | |||
EBIT | |||
Interest | |||
Earnings before taxes | |||
Taxes | |||
Net income | |||
ROE |
1.2 Based on your findings in 1.1 above, which working capital policy would you recommend and why?