Rentz Corporation is investigating the optimal level of current assets for the c
ID: 2793710 • Letter: R
Question
Rentz Corporation is investigating the optimal level of current assets for the coming year. Management expects sales to increase to approxdimately $2 million as a resalt of an asset espansion present y being undertaken. Fixed assets total $2 million, and the firm plans to maintain a 45% d t to assets ratio. Re tzs nterest rate is armd, 9% on bee sh ttem and kngt debt (which the firm uses in its permanent structure). Three alternatives regarding the projected current assets 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 p ey where ment assets ould be 60% of sales bani o entsstad tas should be 13% of total sales, and the federal-plus. state tax rate is 40%. a. What is the expected return on equity under each current assets level? Round your answers to two decimal places Restricted policy Moderate policy Relaxed policy b. In this problem, we assume that expected sales are independent of the current assets investment policy. Is this a vald assumption? L. Yes, sales are controlled only by the degree of marketing effort the firm uses, irrespective of the current asset policies it emplays IL. Yes, the current asset policies followed by the firm mainly influence the level of long-term debt used by the firm III. Yes, the current asset polidies followed by the firm mainly influence the level of fixed assets. . No, this assumption would probably not be valid in a real world situation. A finn's current asset poldes may have a significant effect on sales. V. Yes, this assumption would probably be valid in a real world situation. A firm's current asset polidies have no signilficant effect on sales Select- c. How would the firm's risk be affected by the difterent polidies? The input in the box below will not be graded, but may be reviewed and considered by your instructor. blank Chack My Work OlwExplanation / Answer
Answer a)
b) This is not a valid assumption because a firm's current asset policies may significantly effect sales.It is difficult to determine an optimum current asset level and may not even be possible.
c) The tighter the policy the higher the expected returns.As the current asset level decreases, it might seem that the difference is from accounts receivable.It could be accomplished with higher discounts and a shorter collection period as well. Tighter receivables policies could create additional costs but would most likely reduce bad debt expenses. Lower Inventories could cause a multitude of operational problems and could mean lost sales.
TIGHT $ MODERATE $ RELAXED $ CURRENT ASSETS 900,000 1000,000 1200,000 FIXED ASSETS 2000,000 2000,000 2000,000 TOTAL ASSETS 2900,000 3000,000 3200,000 DEBT 45% 1305000 1350000 1440000 EQUITY 55 % 1595,000 1650,000 1760,000 TOTAL LIABILITY/EQUITY 2900,000 3000,000 3200,000 EBIT 260000 260000 260000 INTEREST 117450 121500 129600 EARNINGS BEFORE TAXES 142550 138500 130400 TAXES 40% 57020 55400 52160 NET INCOME 85530 83100 78240 ROE (NET INCOME / EQUITY X 100) 5.36 % 5.04 % 4.46 %