Rentz Corporation is investigating the optimal level of current assets for the c
ID: 2660617 • Letter: R
Question
Rentz Corporation is investigating the optimal level of current assets for the coming year. Management expects sales to increase to approximately $3 million as a result of an asset expansion presently being undertaken. Fixed assets total $1 million, and the firm plans to maintain a 55% debt-to-assets ratio. Rentz's interest rate is currently 9% 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 14% of total sales, and the federal-plus-state tax rate is 40%.
Restricted policy % Moderate policy % Relaxed policy %Explanation / Answer
Tight Policy
Moderate Policy
Relaxed Policy
Current Assets of TightPolicy ($3,000,000 * 45%) = $1,350,000 Current Assets of Moderate Policy($3,000,000 * 50%) = $1,500,000Current Assets of Relaxed Policy($3,000,000 * 60%) = $1,800,000
Tight Policy
Moderate Policy
Relaxed Policy
Current Assets $1,350,000 $1,500,000 $1,800,000 Fixed Assets $1,000,000 $1,000,000 $1,000,000 Total Assets $2,350,000 $2,500,000 $2,800,000 Debt ratio (55% on Total Assets) $1,292,500 $1,375,000 $1,540,000 Equity $1,057,500 $1,125,000 $1,260,000 Total Debt + Equity $2,350,000 $2,500,000 $2,800,000 EBIT(14% on $3,000,000) $420,000 $420,000 $420,000 Interst on both short & Longterm debt (9%) $116,325 $123,750 $138,600 Earning Before Tax $303,675 $296,250 $281,400 Tax (40%) $121,470 $118,500 $112,560 Net Income $182,205 $177,750 $168,840 Return on Equity (ROE) 17.23% 15.80% 13.40% Return on Equity (ROE) = Net Income /Shareholder's Equity