Rentz Corporation is investigating the optimal level of currentassets for the coming year. Management expects sales to increase toapproximately $2 million as a result of an asset expansionpresently being undertaken. Fixed assets total $3 million, and thefirm plans to maintain a 50% debt-to-assets ratio. Rentz's interestrate is currently 8% on both short-term and long-term debt (whichthe firm uses in its permanent structure). Three alternativesregarding the projected current assets level are underconsideration: (1) a restricted policy where current assets wouldbe only 45% of projected sales, (2) a moderate policy where currentassets would be 50% of sales, and (3) a relaxed policy wherecurrent assets would be 60% of sales. Earnings before interest andtaxes should be 12% of total sales, and the federal-plus-state taxrate is 40%.
- What is the expected return on equity under each current assetslevel? Round your answers to two decimal places.
| Restricted policy | | % |
| Moderate policy | | % |
| Relaxed policy | | % |
- In this problem, we assume that expected sales are independentof the current assets investment policy. Is this a validassumption?
- Yes, the current asset policies followed by the firm mainlyinfluence the level of long-term debt used by the firm.
- Yes, the current asset policies followed by the firm mainlyinfluence the level of fixed assets.
- No, this assumption would probably not be valid in a real worldsituation. A firm's current asset policies may have a significanteffect on sales.
- Yes, this assumption would probably be valid in a real worldsituation. A firm's current asset policies have no significanteffect on sales.
- Yes, sales are controlled only by the degree of marketingeffort the firm uses, irrespective of the current asset policies itemploys.
-Select-IIIIIIIVVItem 4
- How would the firm's risk be affected by the differentpolicies?
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