Question
Rentz Corporation is investigating the optimal level of current assets for the coming year. Management expects sales to increase to approximately $4 million as a
Rentz Corporation is investigating the optimal level of current assets for the coming year. Management expects sales to increase to approximately $4 million as a result of an asset expansion presently being undertaken. Fixed assets total $3 million, and the firm plans to maintain a 60% debt-to-assets ratio. Rentz's interest rate is currently 10% on both short-term and long-term debt (which the firm uses in its permanent structure). Three alternatives regarding the projected current assets level are under consideration: (1) a restricted policy where current assets would be only 45% of projected sales, (2) a moderate policy where current assets would be 50% of sales, and (3) a relaxed policy where current assets would be 60% of sales. Earnings before interest and taxes should be 11% of total sales, and the federal-plus-state tax rate is 40%.
- What is the expected return on equity under each current assets level? Round your answers to two decimal places.
Restricted policy %__ Moderate policy %__ Relaxed policy %__ - In this problem, we assume that expected sales are independent of the current assets investment policy. Is this a valid assumption?
- 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.
- Yes, this assumption would probably be valid in a real world situation. A firm's current asset policies have no significant effect on sales.
- Yes, sales are controlled only by the degree of marketing effort the firm uses, irrespective of the current asset policies it employs.
- Yes, the current asset policies followed by the firm mainly influence the level of long-term debt used by the firm.
- Yes, the current asset policies followed by the firm mainly influence the level of fixed assets.
- How would the firm's risk be affected by the different policies?
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