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F. Naz
F. Naz, Chartered Accountant
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Scott Equipment Organization is investigating various combinations

Customer Question

Scott Equipment Organization is investigating various combinations of short- and long-term debt in financing assets. Assume the organization has decided to employ $30 million in current assets and $35 million in fixed assets in its operations next year, provided the level of current assets, anticipated sales, and EBIT for next year are $60 million and $6 million, respectively. The organization’s income tax rate is 40%. Stockholders’ equity will be used to finance $40 million of assets, with the remainder financed by short- and long-term debt. The organization is considering implementing one of the policies in the diagram.
Policy     In Mil.    LTD%     STD%

Aggress.     24        8.5      5.5
Moderate     18        8.0      5.0
Conserv.     12        7.5      4.5

Determine the following for each policy:

1.Expected rate of return on stockholders’ equity

     
2.Net working capital position


3.Current ratio

Evaluate profitability versus risk trade-offs of these policies. Would you rate them low, medium, or high with respect to profitability? Would you rate them low, medium, or high with respect to risk?

























































Submitted: 7 years ago.
Category: Homework
Expert:  F. Naz replied 7 years ago.

 

 

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Edited by Muhammad Jawaad Ahmed on 4/12/2010 at 7:39 PM EST
Customer: replied 7 years ago.
Do you have the formulas used for the current ratio, return on equity, and net working capital position?
Expert:  F. Naz replied 7 years ago.

 

 

Current Ratio = Current Assets/Current Liabilities

Return on Equity = Profit after tax / Equity

Net Working Capital = Current Assets - Current Liabilities

Customer: replied 7 years ago.
Where did you get the figures for the Interest
Less: Interest See working

 

What is that for and where did it come from? I don't see where that is part of the problem. Please explain

Customer: replied 7 years ago.

I am confused?? You put that Net working capital is Current Assets - current liabilities and Current ratio is Current Assets/ Current Liabilities.

 

On your answer you put that Net Working Capital was 30-24 = 16 but then put a current ratio of 5:4. Wouldn't be 30/40 = 1.25??? Please explain

Expert:  F. Naz replied 7 years ago.

Net workiing capital is the difference between current assets and current liabiliteis therefore it is 30-24 = 6

 

whereas the current ratio is the relationship between current assets and current liabilities therefore total current assets has been divided by current liabilities 30/24 = 5:4

Customer: replied 7 years ago.

I am sorry I made a mistake on my part but when I divide 30/24 you still get 1.25 not 5.4?? Please explain.

 

And the interest part, where did that come from??

Expert:  F. Naz replied 7 years ago.
My answer is not 5.4, it is 5:4. You can represent ratio in two ways either 1.25 times or 5:4, both are same thing. As 5:4 means 5/4 when you do it the result is 1.25 times.
Customer: replied 7 years ago.

And what about the interest?? Where do you come up with that from? What formulas and figures did you use to calculate that???

Expert:  F. Naz replied 7 years ago.

 

Aggressive

1 x .085

24 x .055

 

Moderate

7 x .08

18 x .05

 

 

Convervative

13 x .075

12 x .045

Customer: replied 7 years ago.

I guess I am just confused how you got the figure for the interest? can you show me your calculation of how you got that. Can you show me the step by step calculation as to how you cam up with these figures for interest? Please. I know I am a pain but I am just trying to learn. Your help is greatly appreciated. I just need to understand this last part and I will leave you alone. I promise :-) (Well after I submit payment then I will leave you alone. LOL)

 

aggressive

-1405000

 

Moderate

-1460000

 

Conservative

-1515000

Expert:  F. Naz replied 7 years ago.
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Customer: replied 7 years ago.
Okay thank you I got it now. I just didn't understand that those were percentage rates. Thank you for your time.
Expert:  F. Naz replied 7 years ago.

Hi

 

you are welcome.

 

Take care.