Current assets investment policy Rentz Corporation is investigating the optimal

Question

Current assets investment policy

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 50% debt-to-assets ratio. Rentz's interest rate is currently 10% on both short-term and longer-term debt (which the firm uses in its permanent structure). Three alternatives regarding the projected current asset 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 asset level? Round your answers to two decimal places.

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? The input in the box below will not be graded, but may be reviewed and considered by your instru

Explanation / Answer

All Amounts in $ Details Restricted Policy Moderate policy Relaxed policy Increased sales          4,000,000         4,000,000       4,000,000 Fixed Asset        3,000,000         3,000,000       3,000,000 Current Asset as % of sales 45% 50% 60% Current Asset Amount          1,350,000         1,500,000       1,800,000 Total Assets (current +Fixed Assets)        4,350,000         4,500,000       4,800,000 Debt to Asset Ratio 50% 50% 50% Amount of Debt        2,175,000         2,250,000       2,400,000 Amount of Equity=Total asset-Debt        2,175,000         2,250,000       2,400,000 EBIT            440,000             440,000           440,000 Interest Cost @10% on debt            217,500             225,000           240,000 Earning Before Tax              222,500             215,000           200,000 Less Tax @40%            (89,000)             (86,000)           (80,000) Net Income              133,500             129,000           120,000 Return on Equity=Net Income/Equity= 6.14% 5.73% 5.00% Generally sales and current asset policy have some links. The credit policy to some extent depends the level of increase of sales . So the correct sattement is : 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.

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