Activity: Working Capital Policy

Bob needs help making a decision on the company's working capital policy. He has sent you a memo.

Deliverables

1. Please complete the calculations.
2. Characterize the working capital policies as conservative, moderate, or aggressive.
3. Summarize the main risks and rewards of each approach in a report me.

Memo from Bob Here is an example for the Working Capital Policy Project Assumptions: Debt Equity Ratio: 1.00 Interest: Short-Term Debt 6%, Long-Term Debt 8% Tax Rate: 50% Conservative Current Assets Fixed Assets Total Assets Current Assets Fixed Assets Total Assets Current Liabilities (6% Interest) Long-Term Debt (8% Interest) Equity (Debt Equity Ratio = 1.00) Total Liabilities and Equity Sales EBIT Interest Taxable Income Income Tax at 50% Tax Rate Earnings to Common Stockholders Return on Assets (EBIT/Assets) Return on Equity (Earnings to Common/Commo n Equity) Perceived Risk Moderate Aggressive $61,000 $50,000 $111,000 $61,000 $50,000 $111,000 $50,000 $50,000 $100,000 $50,000 $50,000 $100,000 $38,000 $50,000 $88,000 $38,000 $50,000 $88,000 $0 $25,000 $44,000 $55,500 $25,000 $0 $55,500 $50,000 $44,000 $111,000 $100,000 $88,000 $100,000 $15,000 $4,440 $10,600 $100,000 $15,000 $3,500 $11,500 $100,000 $15,000 $2,640 $12,360 To be calculated To be calculated To be calculated To be calculated To be calculated To be calculated To be calculated To be calculated To be calculated To be calculated To be calculated To be calculated Discuss Discuss Discuss Running head: MEMO FROM BOB 1 Memo from Bob [Insert Name] [Institutional Affiliation] MEMO FROM BOB 2 Here is an example for the Working Capital Policy Project Assumptions: Debt Equity Ratio: 1.00 Interest: Short-Term Debt 6%, Long-Term Debt 8% Tax Rate: 50% Conservative Current Assets Fixed Assets Total Assets Current Assets Fixed Assets Total Assets Current Liabilities Moderate Aggressive $61,000 $50,000 $111,000 $61,000 $50,000 $111,000 $50,000 $50,000 $100,000 $50,000 $50,000 $100,000 $38,000 $50,000 $88,000 $38,000 $50,000 $88,000 $0 $25,000 $44,000 $55,500 $25,000 $0 $55,500 $50,000 $44,000 $111,000 $100,000 $88,000 $100,000 $15,000 $4,440 $10,560 $100,000 $15,000 $3,500 $11,500 $100,000 $15,000 $2,640 $12,360 $5,280 $5,750 $6,180 $5,280 $5,750 $6,180 (6% Interest) Long-Term Debt (8% Interest) Equity (Debt Equity Ratio = 1.00) Total Liabilities and Equity Sales EBIT Interest Taxable Income Income Tax at 50% Tax Rate Earnings to Common MEMO FROM BOB 3 Stockholders Return on Assets 0.15 0.15 0.15 0.0951 0.115 0.140 (EBIT/Assets) Return on Equity (Earnings to Common/Common Equity) Perceived Risks and rewards Risk The Risk opportunity cost of lazy assets Insolvency risk implement because Persistence of permanent some risks. assets are Rewards financed by Low sales Optimum level short-term of funds sources. risk. The risk of bankruptcy and default increases. Rewards Difficult to increases. efficiency Risk No refinancing risk opportunities No interest due to delay in fluctuation risk raw material acquisition and Saves on machinery interest cost breakdowns. High returns on assets Lost Unexpected being shocks as there measured by are no cushions MEMO FROM BOB 4 gross income divided by working capital. or margin in High this financing liquidity position due to increase in current assets. strategy. Running head: MEMO FROM BOB 1 Memo from Bob [Insert Name] [Institutional Affiliation] MEMO FROM BOB 2 Here is an example for the Working Capital Policy Project Assumptions: Debt Equity Ratio: 1.00 Interest: Short-Term Debt 6%, Long-Term Debt 8% Tax Rate: 50% Conservative Current Assets Fixed Assets Total Assets Current Assets Fixed Assets Total Assets Current Liabilities Moderate Aggressive $61,000 $50,000 $111,000 $61,000 $50,000 $111,000 $50,000 $50,000 $100,000 $50,000 $50,000 $100,000 $38,000 $50,000 $88,000 $38,000 $50,000 $88,000 $0 $25,000 $44,000 $55,500 $25,000 $0 $55,500 $50,000 $44,000 $111,000 $100,000 $88,000 $100,000 $15,000 $4,440 $10,560 $100,000 $15,000 $3,500 $11,500 $100,000 $15,000 $2,640 $12,360 50/100*10,560=$5,280 50/100*11,500=$5,750 50/100*12,360=$6,180 (6% Interest) Long-Term Debt (8% Interest) Equity (Debt Equity Ratio = 1.00) Total Liabilities and Equity Sales EBIT Interest Taxable Income Income Tax at 50% Tax Rate Earnings to Common $10,560-$5,280=$5,280 $11,500$5,750=$5,750 $12,360-$6,180=$6,180 MEMO FROM BOB 3 Stockholders (Taxable incomeincome tax) Return on Assets 15,000/100,000=0.15 15,000/100,000=0.15 15,000/100,000=0.15 (EBIT/Assets) Return on Equity (Earnings to $5,280/55,500=0.0951 $5,750/$50,000=0.115 $6,180/$44,000=0.140 Common/Common Equity) Perceived Risks and rewards Risk The opportunity Risk cost of lazy assets increases. Low sales efficiency risk. The risk of High returns on assets being measured by gross income divided by Insolvency risk implement because Persistence of permanent assets some risks. are financed by short-term sources. Optimum level of funds increases. Rewards Difficult to Rewards bankruptcy and default Risk Lost No refinancing opportunities due risk to delay in raw No interest material fluctuation risk acquisition and machinery Saves on breakdowns. interest cost Unexpected shocks as there MEMO FROM BOB 4 working capital. High liquidity are no cushions position due to or margin in this increase in financing current assets. strategy. Running head: MEMO FROM BOB 1 Memo from Bob [Insert Name] [Institutional Affiliation] MEMO FROM BOB 2 Here is an example for the Working Capital Policy Project Assumptions: Debt Equity Ratio: 1.00 Interest: Short-Term Debt 6%, Long-Term Debt 8% Tax Rate: 50% Conservative Current Assets Fixed Assets Total Assets Current Assets Fixed Assets Total Assets Current Liabilities Moderate Aggressive $61,000 $50,000 $111,000 $61,000 $50,000 $111,000 $50,000 $50,000 $100,000 $50,000 $50,000 $100,000 $38,000 $50,000 $88,000 $38,000 $50,000 $88,000 $0 $25,000 $44,000 $55,500 $25,000 $0 $55,500 $50,000 $44,000 $111,000 $100,000 $88,000 $100,000 $15,000 $4,440 $10,560 $100,000 $15,000 $3,500 $11,500 $100,000 $15,000 $2,640 $12,360 $5,280 $5,750 $6,180 $5,280 $5,750 $6,180 (6% Interest) Long-Term Debt (8% Interest) Equity (Debt Equity Ratio = 1.00) Total Liabilities and Equity Sales EBIT Interest Taxable Income Income Tax at 50% Tax Rate Earnings to Common MEMO FROM BOB 3 Stockholders Return on Assets 0.15 0.15 0.15 0.0951 0.115 0.140 (EBIT/Assets) Return on Equity (Earnings to Common/Common Equity) Perceived Risks and rewards Risk The Risk opportunity cost of lazy assets Insolvency risk implement because Persistence of permanent some risks. assets are Rewards financed by Low sales Optimum level short-term of funds sources. risk. The risk of bankruptcy and default increases. Rewards Difficult to increases. efficiency Risk No refinancing risk opportunities No interest due to delay in fluctuation risk raw material acquisition and Saves on machinery interest cost breakdowns. High returns on assets Lost Unexpected being shocks as there measured by are no cushions MEMO FROM BOB 4 gross income divided by working capital. or margin in High this financing liquidity position due to increase in current assets. strategy. Running head: MEMO FROM BOB 1 Memo from Bob [Insert Name] [Institutional Affiliation] MEMO FROM BOB 2 Here is an example for the Working Capital Policy Project Assumptions: Debt Equity Ratio: 1.00 Interest: Short-Term Debt 6%, Long-Term Debt 8% Tax Rate: 50% Conservative Current Assets Fixed Assets Total Assets Current Assets Fixed Assets Total Assets Current Liabilities Moderate Aggressive $61,000 $50,000 $111,000 $61,000 $50,000 $111,000 $50,000 $50,000 $100,000 $50,000 $50,000 $100,000 $38,000 $50,000 $88,000 $38,000 $50,000 $88,000 $0 $25,000 $44,000 $55,500 $25,000 $0 $55,500 $50,000 $44,000 $111,000 $100,000 $88,000 $100,000 $15,000 $4,440 $10,560 $100,000 $15,000 $3,500 $11,500 $100,000 $15,000 $2,640 $12,360 50/100*10,560=$5,280 50/100*11,500=$5,750 50/100*12,360=$6,180 (6% Interest) Long-Term Debt (8% Interest) Equity (Debt Equity Ratio = 1.00) Total Liabilities and Equity Sales EBIT Interest Taxable Income Income Tax at 50% Tax Rate Earnings to Common $10,560-$5,280=$5,280 $11,500$5,750=$5,750 $12,360-$6,180=$6,180 MEMO FROM BOB 3 Stockholders (Taxable incomeincome tax) Return on Assets 15,000/100,000=0.15 15,000/100,000=0.15 15,000/100,000=0.15 (EBIT/Assets) Return on Equity (Earnings to $5,280/55,500=0.0951 $5,750/$50,000=0.115 $6,180/$44,000=0.140 Common/Common Equity) Perceived Risks and rewards Risk The opportunity Risk cost of lazy assets increases. Low sales efficiency risk. The risk of High returns on assets being measured by gross income divided by Insolvency risk implement because Persistence of permanent assets some risks. are financed by short-term sources. Optimum level of funds increases. Rewards Difficult to Rewards bankruptcy and default Risk Lost No refinancing opportunities due risk to delay in raw No interest material fluctuation risk acquisition and machinery Saves on breakdowns. interest cost Unexpected shocks as there MEMO FROM BOB 4 working capital. High liquidity are no cushions position due to or margin in this increase in financing current assets. strategy