Tag Organization is investigating the use of variouscombinations of short-term a

Question

Tag Organization is investigating the use of variouscombinations of short-term and long-term debt in financing itsassets. Assume that the organization has decided to employ $30million in current assets, along with $35 million in fixed assets,in its operations next year. Given the level of current assets,anticipated sales and Earnings Before Interest and Taxes (EBIT) fornext year are $60 million and $6 million, respectively. Theorganization’s income tax rate is 40%; Stockholders’equity will be used to finance $40 million of its assets, with theremainder being financed by short-term and long-term debt.Scott’s is considering implementing one of thefollowing financing policies:

Amount of Short-Term Debt

Financial Policy

In mil.

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

Determine the net working capital position for each of thefinancing policies:

Financial Policy

In mil.

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

Current Assets (CA) $30,000,000 Fixed Assets (FA) $35,000,000 Net Working Capital(NWC)   =   Current Assets - CurrentLiabilities Calcualting Net Working Capital (NWC)for the each of the Financing Policies: Financial Policy Net Working Capital (NWC) Aggressive ($30,000,000 - $24,000,000) = $6,000,000 (Large Amount of Short-term Debt) Moderate ($30,000,000 - $18,000,000) = $12,000,000 (Moderate Amount of Short-term Debt) Conservative ($30,000,000 - $12,000,000)= $18,000,000. (Small Amount of Short-term Debt) Current Assets (CA) $30,000,000 Fixed Assets (FA) $35,000,000 Net Working Capital(NWC)   =   Current Assets - CurrentLiabilities Calcualting Net Working Capital (NWC)for the each of the Financing Policies: Financial Policy Net Working Capital (NWC) Aggressive ($30,000,000 - $24,000,000) = $6,000,000 (Large Amount of Short-term Debt) Moderate ($30,000,000 - $18,000,000) = $12,000,000 (Moderate Amount of Short-term Debt) Conservative ($30,000,000 - $12,000,000)= $18,000,000. (Small Amount of Short-term Debt)

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