16-13. PAYNE PRODUCTS HAD $1.6 MILLION IN SALES REVENUES IN THE MOST RECENT YEAR AND EXPECTS SALES GROWTH TO BE 25% THIS YEAR PAYNE WOULD LIKE TO DETERMINE THE EFFECT OF VARIOUS CURRENT ASSET POLICIES ON ITS FINANCIAL PEPRFORMANCE. PAYNE HAS $1 MILLION OF FIXED ASSETS AND INTENDS TO KEEO ITS DEBT RATIO AT ITS HISTORICAL LEVEL OF 60%. PAYNE'S DEBT INTEREST RATE IS CURRENTLY 8%. YOU ARE TO EVALUATE THREE DIFFERENT ASSET POLICIES: (1) A RESTRICTED POLICY IN WHICH CURRENT ASSETS ARE 45% OF PROJECTED SALES, (2) A MODERATE POLICY WITH 50% OF SALES TIED UP IN CURRENT ASSETS, AND (3) A RELAXED POLICY REQUIRING CURRENT ASSETS OF 60% OF SALES. EARNINGS BEFORE INTEREST AND TAXES ARE EXPECTED TO BE 12% OF SALES. PAYNE'S TAX RATE IS 40%.

A. WHAT IS THE EXPECTED RETURN ON EQUITY UNDER EACH CURRENT ASSET LEVEL?

B.IN THIS PROBLEM, WE HAVE ASSUMED THAT THE LEVEL OF EXPECTED SALES IS INDEPDENT OF CURRENT ASSET POLICY. IS THIS A VALID ASSUMPTION? WHY OR WHY NOT?

C. HOW WOULD THE OVERALL RISK OF THE FIRM VARY UNDEREACH POLICY?

I already have the answers in the back of the book, but need the formula and steps in solving each one.

ROET=11.75%

ROEM=10.80%

ROER=9.16%