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:

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

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

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.

Required:

Determine the return on equity for each plan.

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