Problem: Scott Equipment Organization
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.
• Complete the calculations below.
Amount of Short-Term Debt
|
Financial Policy
|
In mil.
|
LTD (%)
|
STD (%)
|
|
Aggressive
(large amount of short-term debt)
|
$24
|
8.5
|
5.5
|
|
Moderate
(moderate amount of short-term debt)
|
$18
|
8.0
|
5.0
|
|
Conservative
(small amount of short-term debt)
|
$12
|
7.5
|
4.5
|
• Determine the following for each policy:
o Expected rate of return on stockholders’ equity
o Net working capital position
o Current ratio
• 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?