Fin 419 Week 4 Research Paper

Week 4 - Individual Assignment
Brandi Glasco
University of Phoenix
FIN/419
Dr. Bob Woerner
May 23, 2012

Week 4 – Individual Assignment

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.
Amount of Short-Term Debt

|Financial Policy |Millions of |LTD (%) |STD (%) |
| |dollars | | |
|Aggressive |$24 |8.5 |5.5 |
|(large amount of short-term debt) | | | |
|Moderate |$18 |8.0 |5.0 |
|(moderate amount of short-term debt) | | | |
|Conservative |$12 |7.5 |4.5 |
|(small amount of short-term debt) | | | |

Determine the following for each policy:

• Expected rate of return on stockholders’ equity • Net working capital position • Current
ratio

Aggressive Moderate Conservative
EBIT $6,000,000 $6,000,000 $6,000,000
Less: Interest See working (1,405,000) (1,460,000) (1,515,000)
EBT 4,595,000 4,540,000 4,485,000
Less: tax 40% (1,838,000) (1,816,000) (1,794,000)
EAT 2,757,000 2,724,000 2,691,000
Expected rate of return 6.89% 6.81% 6.73%
Net working capital 30-24 =6 million 30-18 =12 million 30-12 =18 million
Current ratio 5:4 5:3 5:2
Profitability High Medium Low
Risk Low medium high
It has been rated due to more return on equity as high in aggressive, medium in moderate and low in conservative
As the liquidity is less in aggressive option it has been rated as low, more liquidity in moderate and conservative as compare to aggressive.
Decision: On the basis of EAT and return on equity it seems that Aggressive policy is recommended but the margin in all three options is so narrow that one can use any options
Working of interest total fund required = $65 million-$40 million from equity = $ 25 from debt
Aggressive Moderate Conservative
Short term 24 x 5.5% = 1.32 18 x 5% = 0.9 12 x 4.5 %= 0.54
Long term 1 x 8.5% 0.085 7 x 8% = 0.56 13 x 7.5% = 0.975
Total 1.405 million 1.46 million
1.515million The aggressive, moderate and, conservative EBIT are all the same number and that is 6 million dollars. The less: Interest see Working for the aggressive is 1,405,000 dollars. The less: Interest See Working for the moderate is 1,406,000 dollars. The less: Interest See Working for the conservative is 1,515,000 dollars. The aggressive EBT is 4,595,000. the moderate EBT is 4,540,000 dollars. The conservative EBT is 4,485,000 dollars. The aggressive Less:tax 40% is 1,838,000 dollars. The moderate less: tax 40% is 1,816,000 dollars. The conservative Less: tax 40% is 1,794,000 dollars. The aggressive EAT is 2,757,000 dollars. The moderate EAT is 2,724,000 dollars. The conservative EAT is 2,691,000 dollars. The aggressive Expected rate of return is 6.89% . The moderate Expected rate of return is 6.81%. The conservative Expected rate of return is 6.73%. The aggressive Net working Capital is 30-24= 6 million. The moderate Net working Capital is 30-18=12 million. The conservative Net Working Capital is 30-12=18 million. The aggressive Current ratio is 5:4. The moderate Current Ratio is 5:3. The conservative Current Ratio is 5:2. The aggressive Profitability is high. The moderate profitability is medium. The conservative profitability is low. The aggressive risk is Low, the moderate risk is medium, and the conservative risk is high.