Question

Payne Products had $3.2 million in sales revenues in the most recent year and expects sales growth to be 25% this year. Payne would like to determine the effect of various current assets policies on its financial performance. Payne has $1 million of fixed assets and intends to keep its debt ratio at its historical level of 50%. Payne's debt interest rate is currently 9%. You are to evaluate three different current asset policies: (1) a tight policy in which current assets are 45% of projected sales, (2) a moderate policy with 50% of sales tied up in current assets, and (3) a relaxed policy requiring current assets of 60% of sales. Earnings before interest and taxes is expected to be 12% of sales. Payne's tax rate is 40%. a. What is the expected return on equity under each current asset level? Round your answers to two decimal places. Tight policy Moderate policy Relaxed policy % b. In this problem, we have assumed that the level of expected sales is independent of current asset policy. Is this a valid assumption? -Select- I. 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. II. Yes, this assumption would probably be valid in a real world situation. A firm's current asset policies have no significant effect on sales. III. Yes, sales are controlled only by the degree of marketing effort the firm uses, irrespective of the current asset policies it employs IV. Yes, the current asset policies followed by the firm mainly influence the level of long-term debt used by the firm. V. Yes, the current asset policies followed by the firm mainly influence the level of fixed assets. Why or why not?

Answer 1

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WORKING CAPITAL APPROACH - Microsoft Excel (Product Activation Failed) Review View Add-Ins File Home Insert Page Layout Formulas Data - 2x % Cut General Wrap Text Merge Merge & Center Center m Find & 4:0 .00 8.9 Insert Delete Format $ - % % Number Conditional Format Formatting as Table Styles Cell Styles Σ AutoSum : A Fill 2 Sort & 2 Clear Filter Editing Select Cells BC BD BE BE BG BH BI BJ в ВК 185 FIXED ASSETS 1000000 100% TOTAL ASSETS 2800000 50% DEBT 1400000 50% EQUITY 1400000 186 1000000 3000000 1500000 1500000 1000000 3400000 1700000 1700000 Calibri -11AA = = = Dr E Copy Paste B Format Painter I U - D SF A Clipboard Font Alignment BJ198 AW AX AY AZ BA BB 183 184 SALES 4000000 [3200000 x 1.25] CURRENT ASSETS RESTRICTED POLICY 1800000 187 45% OF SALES 188 MODERATE POLICY 2000000 189 50% OF SALES 190 RELAXED POLICY 2400000 191 60% OF SALES 192 EBIT % of sales = 12% 194 195 RESTRICTED 196 EBIT 480000 197 INTEREST 126000 198 EBT 354000 199 TAX (40%) 141600 200 NET INCOME 212400 201 RETURN ON EQUITY 15.17% Sheet1 Sheet2 Z SCORE insu pv fv cash opti LINE OF CREDIT Rea ferences 193 rate of interest = 9% MODERATE 480000 135000 345000 138000 207000 13.80% eoq_miller CARD RELAXED 480000 153000 (9% ON DEBT) 327000 130800 196200 11.54% [NET INCOME/EQUITY] BANKER ACCEPTANC FACTOR SI DISC FOCAL WC REQUIRE Sheet3 | |BOJ 130% T 0 | + .. 9 * 4 OENG 08-11-2019

WORKING CAPITAL APPROACH - Microsoft Excel (Product Activation Failed) Review View Add-Ins File Home Insert Page Layout Formulas Data - 2x % Cut Σ AutoSum : A Fill 2 Clear Sort & Filter Editing Find & Select Cells BE BF BI BJ BK A Calibri -11AA = = = Dr Wrap Text General E Copy Paste Format Painter B I U - D A Merge & Center $ - % 8. Formatting as Table Styles Clipboard Font Alignment Number Styles AX276 AW AX AY AZ BA BB BC BD BG BH 274 275 _NO, THIS ASSUMPTION IS NOT VALID AS CURRENT ASSET POLICIES DO HAVE SIGNIFICANT EFFECT ON SALES 276 277 278 279 280 281 282 283 284 285 286 287 288 289 290 291 292 Z SCORE insu pv fv Sheet1 Sheet2 ferences cash opti LINE OF CREDIT eoq_miller CARD BANKER ACCEPTANC FACTOR SI DISC FOCAL WC REQUIRE Sheet3 | |BOJ 130% T | + Rea 0 ODOB 9 . * ENG 03-11-2019