Three companies€”Aggressive, Moderate, and Conservative€”have different working capital management policies as implied by their names. For example, Aggressive employs only minimal current assets, and it finances almost entirely with current liabilities plus equity. This restricted approach has a dual effect. It keeps total assets low, which tends to increase return on assets, but because of stock-outs and credit rejections, total sales are reduced, and because inventory is ordered more frequently and in smaller quantities, variable costs are increased. Condensed balance sheets for the three companies follow:

The cost of goods sold functions for the three firms are as follows:
Because of the working capital differences, sales for the three firms underdifferent economic conditions are expected to vary as follows:

a. Construct income statements for each company for strong, average, and weak economies using the following format:

Sales
Less: Cost of goods sold
Earnings before interest and taxes (EBIT)
Less: Interest expense
Earnings before taxes (EBT)
Less: Taxes (at 40%)
Net income (NI)

b. Compare the returns on equity for the companies. Which company is best in a strong economy? In an average economy? In a weak economy?
c. Suppose that, with sales at the average-economy level, short-term interest rates rose to 20 percent. How would this affect the three firms?
d. Suppose that because of production slowdowns caused by inventory shortages, the aggressive company€™s variable cost ratio rose to 80 percent. What would happen to its ROE? Assume a short-term interest rate of 12 percent.
e. What considerations for the management of working capital are indicated by this problem?

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Moderate Conservative Aggressive Current assets $225,000 $300,000 $450,000 300,000 Fixed assets 300,000 300,000 $600.000 $525.000 Total assets $750,000 Current liabilities (cost = 12%) Long-term debt (cost = 10%) Total debt $300,000 $150,000 $75,000 %3D 150,000 $300,000 300,000 $375,000 375,000 $300,000 Equity Total liabilities and equity 225,000 300,000 $525.000 $600.000 $750.000 0.75 Current ratio 2.0 6.0 Aggressive: Cost of goods sold = $300,000 Cost of goods sold = $405,000 Conservative: Cost of goods sold = $577,500 Cost of Goods Sold = Fixed Costs + Variable Costs + 0.70(Sales) + 0.65(Sales) + 0.60(Sales) | Moderate: %3D