Simmons Industries is considering two alternative working capital investment and financing policies. Policy A requires the firm to keep its current assets at 70%
of forecasted sales and to finance 75% of its debt requirements with longterm debt (and 25% with short-term debt). Policy B, on the other hand, requires the firm to keep current assets at 50% of forecasted sales and to finance 50% of its debt requirements with long-term debt (and 50% with short-term debt). Forecasted sales for next
year are $20 million. Earnings before interest and taxes are projected to be 20% of sales. The firm's corporate income tax rate is 40%. Its fixed assets total $10 million. The firm desires to maintain its existing capital structure that consists of 50% debt (both long-term and short-term) and 50% equity. Interest rates on short- and long-term debt are 8% and 10%, respectively.
Determine the expected rate of return on equity next year for Simmons Industries under each of the working capital policies.

Answer rating: 100% (QA)

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