HW-1569 FIN419 Scott equipment

Scott Equipment Organization is investigating various combinations of short- and long-term debt in financing assets. Assume the organization has decided to employ $10 million in current assets and $15 million in fixed assets in its operations next year, and EBIT for next year is $8 million. The organization’s income tax rate is 40%. Stockholders’ equity will be used to finance $15 million of assets, with the remainder financed by short- and long-term debt. The organization is considering implementing one of the policies below.

Current Assets: $10 million
Fixed Assets: $15 million
Total Assets : $25 million

Stockholders’ Equity: $15 million
Total Amount of Assets to be financed by debt: $10 million

Tax Rate: 40%
Total EBIT: $8 million

Aggressive Strategy
Short Term Debt: $8 million, 6% interest rate
Long Term Debt: $2 million, 8% interest rate

Moderate Strategy
Short Term Debt: $5 million, 5.5% interest rate
Long Term Debt: $5 million,7.5% interest rate

Conservative Strategy
Short Term Debt: $3 million, 5.25% interest rate
Long Term Debt: $7 million, 7.25% interest rate

Determine the following for each policy:

• Net Income
• Expected rate of return on stockholders’ equity (Net Income/Equity)
• Net working capital position (Current Assets - Current Liabilities)
• Current ratio (Current Assets/Current Liabilities)
• Would you rate them low, medium, or high with respect to profitability?
• Would you rate them low, medium, or high with respect to risk?
• What is your recommendation to management? Why?

Write a memo/email to management in which you 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? What is your recommendation to management?


Answer will be sent by email as attachment.