(20 pts) 7. The Kyle Corporation is attempting to determine the optimal level of current assets for the coming year. Management expects sales to increase to approximately $30 million, because of an asset expansion currently being undertaken. Fixed assets total $40 million, and the firm finances 40 percent of its total assets with debt of which half is short-term debt and the rest with common equity. Kyles interest cost is currently 6 percent on short-term debt and 12 percent on long-term debt. Three alternatives regarding the projected current asset level are available to the firm:

1. An aggressive policy requiring current assets of 40 percent of projected sales.

2. A moderate policy of 50 percent of sales in current assets.

3. A conservative policy requiring current assets of 70 percent of sales. The firm expects to generate EBIT at a rate of 10 percent in total sales. The tax rate for Kyle is 20 percent.

Require

a) Determine the return on equity for each plan.

b) Which plan has the most risk and explain why? Which plan would you recommend?