ASSIGNMENT # 2

STUDENT NAME: QURAT- ANWAR I.D #:

19095
TEACHER: MA’AM SUNDUS WAQAR DUE
DATE: 29-8-21
COURSE: FINANCIAL STRATEGY N POLICY MARKS: 5
MARKS

QUESTION:
Rentz Corporation is investigating the optimal level of current assets for the coming year. Management
expects sales to increase to approximately $2 million as a result of an asset expansion presently being
undertaken. Fixed assets total $1 million, and the firm plans to maintain a 60% debt ratio. Rentz ’s interest
rate is currently 8% on both short-term and longer-term debt (which the firm uses in its permanent
structure).
Three alternatives regarding the projected current assets level are under consideration: (1) a tight policy
where current assets would be only 45% of projected sales, (2) a moderate policy where current assets
would be 50% of sales, and (3) a relaxed policy where current assets would be 60% of sales. Earnings
before interest and taxes should be 12% of total sales, and the federal-plus-state tax rate is 40%.

a. What is the expected return on equity under each current asset level?
b. In this problem, we assume that expected sales are independent of the current asset policy. Is this
a valid assumption? Why or why not?
c. How would the firm’s risk be affected by the different policies
 ANSWER:
PART (A):
a. What is the expected return on equity under each current asset level?

ANSWER:
EXPECTED RETURN ON EQUITY UNDER EACH CURRENT ASSET LEVEL:
The three potential policies are given to find out the return on equity .For this divide the
net income by equity .With all the policies ,the chart based describe how to calculate the
equity and the net income. The findings are labelled.

Equity and net income calculation

particulars Restricted policy Moderate policy Relaxed policy
Sales 2,000,000 2,000,000 2,000,000
Ratio 45% of sales 50% of sales 60% of sales
Current Assets $9,00,000 $10,00,000 $12,00,000
Fixed Assets $10,00,000 $10,00,000 $10,00,000
Total Assets $19,00,000 $20,00,000 $22,00,000

Debt (60% of asset) $11,40,000 $12,00,000 $13,20,000

Equity $7,60,000 $8,00,000 $8,80,000
Total liabilities 1,900,000 2,000,000 2,200,000

EBIT(12% of total tax) $2,40,000 $2,40,000 $2,40,000

Interest(8% of debt) $91,200 $96,000 $1,05,600
EBT $1,48,000 $1,44,000 $1,34,400
Tax (40% of EBT) $59,520 $57,600 $53,760
Net Income $89,280 $86,400 $80,640

ROE 11.75% 10.80% 9.16%

With the given net income and equity for each policy, find out the return on equity
for each of them.
TIGHT POLICY RETURN ON EQUITY =NET INCOME/ EQUITY
=$89,280/760,000
TIGHT POLICT RETURNON EQUITY =0.1175 OR 11.75%

MODERATE POLICY RETURN ON EQUITY=NET INCOME / EQUITY

=86,400/800,000
MODERATE POLICY RETURN ON EQUITY =0.108 OR 10.8%

RELAXED POLICY RETURN ON EQUITY=NET INCOME / EQUITY

=80,640/880,000
RELAXED POLICY RETURN ON EQUITY =0.0916 OR 9.16%

PART B:
a. In this problem, we assume that expected sales are independent of the current asset
policy. Is this a valid assumption? Why or why not------?
ANSWER:
Actually the assumption which is provided is not Logical. The current investment policies may
have the strong effect on the expected sales. The discount collection policies and the account
receivables all are the features that influenced the Projected Sales.
PART (C):
C: How would the firm’s risk be affected by the different policies-----?

ANSWER:
FIRM’S RISK LEVEL EFFECT BY DIFFERENT POLICIES:
The three policies have different effect on the firm “RISK LEVEL”. In this case the
 CONSERVATIVE APPROACH-------------------------SAFEST
So,
If the company requires to stay Risk Conservative, it would go this way.

 MODERATE POLICY-----------------MEDIUM OF THE RISK SCALE.

And,
If a company is ready to take a Risk or chance it can pick this policy,
In this ,
RISKIEST POLICY----------------------------AGGRESSIVE ONE
And the probability of Bankruptcy is SIGNIFICANTLY LARGER in this case.

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