New Scott Equipment Organization
The New Scott Equipment Organization Paper
FIN/419: Finance for Decision Makers
Scott Equipment Organization is investigating the use of various combinations of short-term and long-term debt in financing its assets. The organization has decided to employ $25 million in current assets, along with $40 million in fixed assets, in its operations next year. Anticipated sales and Earnings Before Interest and Taxes (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 its assets, with the remainder being financed by short-term and long-term debt. Scott 's is considering implementing _one_ of the following financing policies: …show more content…
BALANCE SHEET
Table/chart/diagram/image is missing. Please download the Word document to view it.
INCOME STATEMENT
Table/chart/diagram/image is missing. Please download the Word document to view it.
EXPECTED RATE OF RETURN ON STOCKHOLDERS ' EQUITY
ROE (RETURN ON COMMON EQUITY) = EAT (EARNINGS AFTER TAXES) / EQUITY
AGGRESSIVE
Interest = ($20,000,000 x .055) + ($5,000,000 x .085) = $1,525,000
EBT = EBIT - interest = $6,000,000 - 1,525,000 = $4,475,000
Taxes = EBT x 40% = $4,475,000 x .40 = $1,790,000
EAT = EBT - taxes = $4,475,000 - 1,790,000 = $2,685,000
ROE = EAT / equity = $2,685,000 / 40,000,000 = 6.71%
MODERATE
Interest = ($15,000,000 x .05) + ($10,000,000 x .08) = $1,550,000
EBT = EBIT - interest = $6,000,000 - 1,550,000 = $4,450,000
Taxes = EBT x 40% = $4,450,000 x .40 = $1,780,000
EAT = EBT - taxes = $4,450,000 - 1,780,000 = $2,670,000
ROE = EAT / equity = $2,685,000 / 40,000,000 = 6.68%
CONSERVATIVE
Interest = ($10,000,000 x .045) + ($15,000,000 x .075) = $1,575,000
EBT = EBIT - interest = $6,000,000 - 1,575,000 = …show more content…
Although the aggressive policy will pay the most taxes, it will result in the highest return on equity at 6.71%, which is better for the owners. But the higher profitability brings with it greater risk. The net working capital is $10 million less than the conservative policy coupled with the lowest current ratio of 1.25 indicates the possibility that Scott Equipment Organization will be unable to pay its bills as they come due. The conservative financial policy has the lowest profitability and the lowest risk, but has the highest net working capital of $15 million and current ratio of 2.50. This indicates that the company is in a good position to pay its bills as they come due. The difference in the return on equity is small at 0.07%. The choice of which financial policy is best for Scott Equipment Organization is dependent on the risk preference of the decision
FIN/419: Finance for Decision Makers
Scott Equipment Organization is investigating the use of various combinations of short-term and long-term debt in financing its assets. The organization has decided to employ $25 million in current assets, along with $40 million in fixed assets, in its operations next year. Anticipated sales and Earnings Before Interest and Taxes (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 its assets, with the remainder being financed by short-term and long-term debt. Scott 's is considering implementing _one_ of the following financing policies: …show more content…
BALANCE SHEET
Table/chart/diagram/image is missing. Please download the Word document to view it.
INCOME STATEMENT
Table/chart/diagram/image is missing. Please download the Word document to view it.
EXPECTED RATE OF RETURN ON STOCKHOLDERS ' EQUITY
ROE (RETURN ON COMMON EQUITY) = EAT (EARNINGS AFTER TAXES) / EQUITY
AGGRESSIVE
Interest = ($20,000,000 x .055) + ($5,000,000 x .085) = $1,525,000
EBT = EBIT - interest = $6,000,000 - 1,525,000 = $4,475,000
Taxes = EBT x 40% = $4,475,000 x .40 = $1,790,000
EAT = EBT - taxes = $4,475,000 - 1,790,000 = $2,685,000
ROE = EAT / equity = $2,685,000 / 40,000,000 = 6.71%
MODERATE
Interest = ($15,000,000 x .05) + ($10,000,000 x .08) = $1,550,000
EBT = EBIT - interest = $6,000,000 - 1,550,000 = $4,450,000
Taxes = EBT x 40% = $4,450,000 x .40 = $1,780,000
EAT = EBT - taxes = $4,450,000 - 1,780,000 = $2,670,000
ROE = EAT / equity = $2,685,000 / 40,000,000 = 6.68%
CONSERVATIVE
Interest = ($10,000,000 x .045) + ($15,000,000 x .075) = $1,575,000
EBT = EBIT - interest = $6,000,000 - 1,575,000 = …show more content…
Although the aggressive policy will pay the most taxes, it will result in the highest return on equity at 6.71%, which is better for the owners. But the higher profitability brings with it greater risk. The net working capital is $10 million less than the conservative policy coupled with the lowest current ratio of 1.25 indicates the possibility that Scott Equipment Organization will be unable to pay its bills as they come due. The conservative financial policy has the lowest profitability and the lowest risk, but has the highest net working capital of $15 million and current ratio of 2.50. This indicates that the company is in a good position to pay its bills as they come due. The difference in the return on equity is small at 0.07%. The choice of which financial policy is best for Scott Equipment Organization is dependent on the risk preference of the decision