ABC Corporation is considering what level of current assets to maintain, as well as whether to use more or less long-term debt, as opposed to short-term debt.

Factors to consider:

Fixed assets - $6,000,000

Earnings before interest and taxes - $ 900,000

Tax rate 25 percent

Optimal capital structure 60 percent equity, 40 percent debt

Interest on short-term debt 5 percent

Interest on long-term debt 9 percent

Current asset level possibilities. Plan 1 - $1,000,000 Plan 2 - $1,500,000.

Level of short-term debt possibilities. Plan 1 75 percent of total debt. Plan 2 20 percent of total debt.

a) Calculate the return on equity for Plan 1 and Plan 2.

b) Explain which plan is the more risky.

c) Discuss which plan you would choose.