Reynolds Equipment Company is investigating the use of various combinations of short-term and long-term debt in financing its assets. Assume that the company has decided to employ $30 million in current assets, along with $35 million in fixed assets, in its operations next year. Given this level of current assets, anticipated sales and EBIT for next year are $60 million and $6 million, respectively. The company’s income tax rate is 40 percent. Stockholders’ equity will be used to finance $40 million of its assets, with the remainder being financed by short-term and long-term debt. Reynolds is considering implementing one of the following financing policies: LO1 Amount of Short-Term Debt (in Millions of Dollars)
Interest Rate Financing Policy LTD (%) STD (%)
Aggressive (large amount of short-term debt)
$24 8.5 5.5 Moderate (moderate amount of short-term debt)
18 8.0 5.0 Conservative (small amount of short-term debt)
12 7.5 4.5

a. Determine the following for each of the financing policies:
i. Expected rate of return on stockholders’ equity ii. Net working capital position •iii. Current ratio

b. Evaluate the profitability versus risk trade-offs of these three policies