Q19 Edwards Enterprises follows a moderate current asset investment policy, but
ID: 2755603 • Letter: Q
Question
Q19
Edwards Enterprises follows a moderate current asset investment policy, but it is now considering a change, perhaps to a restricted or maybe to a relaxed policy. The firm’s annual sales are $400,000; its fixed assets are $100,000; its target capital structure calls for 50% debt and 50% equity; its EBIT is $35,000; the interest rate on its debt is 10%; and its tax rate is 40%. With a restricted policy, current assets will be 15% of sales, while under a relaxed policy they will be 25% of sales. What is the difference in the projected ROEs between the restricted and relaxed policies?
Select one:
a. 5.25%
b. 4.73%
c. 4.25%
d. 6.35%
e. 5.78%
Explanation / Answer
a. 5.25%
Restricted Relaxed CA $ 60,000 400000*15% $100,000 FA 100,000 100,000 Total assets $160,000 $200,000 Debt $ 80,000 $100,000 Equity 80,000 100,000 Total liab. & capital $160,000 $200,000 EBIT $ 35,000 $ 35,000 Interest 8,000 10,000 EBT $ 27,000 $ 25,000 Taxes 10,800 10,000 NI $ 16,200 $ 15,000 ROE 20.25% 15.00% Difference in ROE = 5.25%Related Questions
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