Question

Big corporation follows a moderate current asset investmentpolicy, but is now considering a change, perhaps to a restricted or maybe to a relaxedpolicy. Bc annual sales are 400000 its fixed aset are 100000 its target capital structure calls for50% debt and 50% equity its EBIT is 55000 the interest rate on debt is 9% and its tax rate is 25% with a resticted policy, current assets will be 15% of sales whileunder a relaxed policy,current asets will be 25% of sales. what is the differences in the projexted ROEs between the restricted and relaxed policy

Answer 1

  

	Restricted	Relaxed
Current Assets	15% of Sales = 0.15 x $400,000 = $60,000	25% of Sales = 0.25 x $400,000= $100,000
Fixed Assets	$100,000	$100,000
Total Assets	$160,000	$200,000
Debt(50% of Assets)	$80,000	$100,000
Equity	$80,000	$100,000
Total Liab. & Capital	$160,000	$200,000

	Restricted	Relaxed
EBIT	$55,000	$55,000
(-) Interest @9%	$7,200	$9,000
EBT	$47,800	$46,000
Taxes(@25%)	11,950	11,500
Net Income	$35,850	$34,500

ROE(NI/Total Equity) $35,850/$80,000 = 44.81% $34,500/$100,000 = 34.50%

Difference in ROE = 44.81% - 34.50% = 10.31%