Prior to beginning work on this discussion, read Chapter 16 and 19 of your textbook, and test your knowledge in the MindTap Practice Chapter 16 Problem 6 located in Ch 16: End-of-Chapter Problems. Although not required, it is recommended that you also review the chapter videos and flashcards available in the recommended resources section of your course.
The director of finance has forwarded you a scenario project to assist him in gaining some insight into the profitability and risk trade-offs of alternative polices. This insight will assist in making better decisions concerning the company working capital policy, which may lead to an increase in shareholder wealth.
For this scenario project, you will investigate the best combinations of short-term and long-term debt to use in financing the company assets. The director of finance is considering implementing one of the following financing policies below: Aggressive, Moderate, or Conservative. Ensure you show your work for all computations:
Use the following information and assumptions in your scenarios:
The company’s annual sales and earnings before interest and taxes (EBIT) from its most recent 10-K report.
The company’s current assets from its most recent 10-K report.
The company’s fixed assets from its most recent 10-K report.
Use a fixed tax rate of 23.5% in all three scenarios.
Use the following growth assumptions to calculate Sales, EBIT, and current assets for each scenario:
Sales Growth RateEBIT Growth RateCurrent Assets Growth RateAggressive Scenario15%15%15%Moderate Scenario10%10%10%Conservative Scenario5%5%5%
Use the following assumptions to compute interest expense on long-term debt and short-term debt in each scenario:
Short-Term Debt Interest RateLong-Term Debt Interest RateAggressive Scenario4%7%Moderate Scenario3.5%6%Conservative Scenario3%5%
Use the following assumptions to calculate current liabilities as a % of projected current assets for each scenario:
Current LiabilitiesAggressive Scenario80%Moderate Scenario60%Conservative Scenario40%
Assume current asset plus fixed assets are the total assets in all three scenarios.
Hold the total debt / total assets ratio at 50% for all three scenarios. Therefore, stockholders’ equity is 50% of total assets in all three scenarios.
Long-term debt equals total debt less current liabilities in all three scenarios.
For purposes of this assignment, current liabilities and short-term liabilities are the same thing, and there are no other current liabilities.
In your paper, determine the following for each of the three financing policies (Aggressive, Moderate, and Conservative):
Compute the expected rate of return on stockholders’ equity.
Compute the net working capital position.
Compute the current ratio.
Analyze the profitability versus risk trade-offs of these three polices.
Recommend a specific course of action to consider that will assist in making better decisions concerning the company working capital policy which may lead to an increase in shareholder wealth.