Question
Current Asset Usage Policy Payne Products had $1.6 million in sales revenues in the most recent year and expects sales growth to be 25% this
Current Asset Usage Policy
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 assets policies on its financial performance. Payne has $1 million of fixed assets and intends to keep its debt ratio at its historical level of 50%. Payne's debt interest rate is currently 8%. You are to evaluate three different current 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 11% of sales. Payne's tax rate is 25%.
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What is the expected return on equity under each current asset level? Do not round intermediate calculations. Round your answers to two decimal places.
Restricted policy: % Moderate policy: % Relaxed policy: % -
In this problem, we have assumed that the level of expected sales is independent of current asset policy. Is this a valid assumption?
I. Yes, this assumption would probably be valid in a real world situation. A firm's current asset policies have no significant effect on sales. II. No, this assumption would probably not be valid in a real world situation. A firm's current asset policies may have a significant effect on sales. III. Yes, this is a valid assumption. The current asset policies followed by the firm mainly influence the level of long-term debt used by the firm. IV. Yes, this is a valid assumption. The current asset policies followed by the firm mainly influence the level of fixed assets. V. Yes, this is a valid assumption. Sales are controlled only by the degree of marketing effort the firm uses, irrespective of the current asset policies it employs.
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