Equinox Corporation is attempting to determine the optimal level of current assets for the coming year. Management

Question:

Equinox is attempting to determine the optimal level of current assets for the coming year. Management expects sales to increase to approximately $5 million as a result of an asset expansion presently being undertaken. Fixed assets total $3 million, and the firm wishes to maintain a 60% debt ratio. Equinox's interest cost is currently 6% on both short-term and longer term debt (which the firm uses in its permanent structure). Three alternatives regarding the projected current asset level are available to the firm: (1) a tight policy requiring current assets of only 45% of projected sales, (2) a moderate policy of 50% of sales in current assets, and (3) a relaxed policy requiring current assets of 60% of sales. The firm expects to generate earnings before interest and taxes at a rate of 12% on total sales.
a. What is the on equity under each current asset level? (Assume a 30% effective tax rate.)
b. In this problem, we have assumed that the level of expected sales is independent of cur- rent asset policy. Is this a valid assumption?
c. How would the overall riskiness of the firm vary under each policy? Corporation
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