Based on the following scenario,complete the calculations below: Scott Equipment

Question

Based on the following scenario,complete the calculations below:

Scott Equipment Organization isinvestigating the use of various combinations of short-term andlong-term debt in financing its assets. Assume that theorganization has decided to employ $30 million in current assets,along with $35 million in fixed assets, in its operations nextyear. Given the level of current assets, anticipated sales andEarnings Before Interest and Taxes (EBIT) for next year are $60million and $6 million, respectively. The organization’sincome tax rate is 40%; Stockholders’ equity will be used tofinance $40 million of its assets, with the remainder beingfinanced by short-term and long-term debt. Scott’s isconsidering implementing one of the followingfinancing policies:

mount of Short-TermDebt

Financial Policy

Inmil.

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

a.       Determine the following for each of the financingpolicies:

1)       Expected rate of return on stockholders’equity

2)       Net working capital position

3)       Current ratio

Financial Policy

Inmil.

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

Explanation / Answer

Aggressive:

         Profitabilityand risk are at a high   

Moderate:

         Profitabilityand risk is at moderate   

Conservative:

         Profitabilityand risk are low

The Scott equipment organization will be better off choosing themore aggressive choice of the three. This is due to theaggressive risk bringing in more on the net equity and the ROE(return on equity). The high risk rate does pose as a negativefor the organization though, it could cause lenders to see this asa threat and lending might be harder to find for shorterfinancing. The net income for all three models is fairly allwithin a short amount with Aggressive being 2.75, moderate 2.72 andconservative 2.69. The higher risk is just that for thecompany, a high risk and there are dangers that can be everpresent, but if the company is looking for a faster way to be moreprofitable, aggressive is the option Scott Equipment Organizationis looking for.

Aggressive Moderate Conservative Balance sheet: C/A $ 30           C/L$24               F/A $ 35          LTD$1                       Equity $40 T/A $ 65 Balance sheet: C/A $  30         C/L$18               F/A $    35      LTD $7                        Equity $40 T/A $65 Balance sheet: C/A $30           C/L$ 12mil              F/A $ 35          LTD$13                        Equity $40 T/A $65 Income Statement: EBIT               $6 million Int. exp.          $1.405 EBT               $4.595 TAX ES          $1.838 EAT                $ Income Statement: EBIT               $6 million Int. exp.          $1.46 EBT               $4.54 TAX ES          $1.816 EAT                $ Income Statement: EBIT              $6 million Int. exp.          $1.515 EBT               $4.485 TAX ES          $1.794 EAT               $ ROE:             6.89 % ROE:                 6.81    % ROE:                 6.73       % Net Working Capital: NWC- = CA – CL $ 6 Net Working Capital: NWC- = CA – CL $   12 Net Working Capital: NWC- = CA – CL $ 18 Current Ratio CR = CA/CL     1.25 Current Ratio CR = CA/CL       1.67 Current Ratio CR = CA/CL      2.5

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