Working Captial Policies
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Scott Equipment Organization is investigating various combinations of short- and long-term debt in financing assets. Assume the organization has decided to employ $30 million in current assets and $35 million in fixed assets in its operations next year, provided the level of current assets, anticipated sales, and EBIT for next year are $60 million and $6 million, respectively. The organization's income tax rate is 40%. Stockholders' equity will be used to finance $40 million of assets, with the remainder financed by short- and long-term debt. The organization is considering implementing one of the policies in the diagram.
Amount of Short-Term Debt
Financial Policy In mil. LTD (%) STD (%)
Aggressive
(large amount of short-term debt) $24 8.5 5.5
Moderate
(moderate amount of short-term debt) $18 8.0 5.0
Conservative
(small amount of short-term debt) $12 7.5 4.5
? Determine the following for each policy:
o Expected rate of return on stockholders' equity
o Net working capital position
o Current ratio
? Evaluate profitability versus risk trade-offs of these policies. Would you rate them low, medium, or high with respect to profitability? Would you rate them low, medium, or high with respect to risk?
The book that is being used is Principles of Finance by Kawrence Gitman 2005
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The solution explains how to evaluate different working capital policies
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Scott Equipment Organization is investigating various combinations of short- and long-term debt in financing assets. Assume the organization has decided to employ $30 million in current assets and $35 million in fixed assets in its operations next year, provided the level of current assets, anticipated sales, and EBIT for next year are $60 million and $6 million, respectively. The organization's income tax rate is 40%. Stockholders' equity will be used to finance $40 million of assets, with the remainder financed by short- and long-term debt. The organization is considering implementing one of the policies in the diagram.
Amount of Short-Term Debt
Financial Policy In mil. LTD (%) STD (%)
Aggressive
(large amount of short-term debt) $24 8.5 5.5
Moderate
(moderate amount of short-term debt) $18 8.0 5.0
Conservative
(small ...
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