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Rentz Corporation is determining the optimal level of current assets for the coming year based on an expected increase in sales to $2 million and fixed assets of $1 million. They are considering a tight policy with current assets at 45% of sales, a moderate policy at 50% of sales, or a relaxed policy at 60% of sales. The document provides information on interest rates and expected earnings to calculate return on equity under each alternative.
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Problem Illustration on Assets Investment Policy.docx
Rentz Corporation is determining the optimal level of current assets for the coming year based on an expected increase in sales to $2 million and fixed assets of $1 million. They are considering a tight policy with current assets at 45% of sales, a moderate policy at 50% of sales, or a relaxed policy at 60% of sales. The document provides information on interest rates and expected earnings to calculate return on equity under each alternative.
Rentz Corporation is determining the optimal level of current assets for the coming year based on an expected increase in sales to $2 million and fixed assets of $1 million. They are considering a tight policy with current assets at 45% of sales, a moderate policy at 50% of sales, or a relaxed policy at 60% of sales. The document provides information on interest rates and expected earnings to calculate return on equity under each alternative.
Rentz Corporation is investigating the optimal level of current assets
for the coming year.
Management expects sales to increase to approximately $2 million as a result of an asset expansion presently being undertaken. Fixed assets total $1 million, and the firm plans to maintain a 60% debt ratio. Rentzs interest rate is currently 8% 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 tight policy where current assets would be only 45% of projected sales, (2) a moderate policy where current assets would be 50% of sales, (3) a relaxed policy where current assets would be 60% of sales.
Earnings before interest and taxes should be 12% of total sales, and the federal-plus-state tax rate is 40%.
a. What is the expected return on equity under each current asset level?
b. How would the firms risk be affected by the different policies?