Your company wants to establish its current assets policy. Fixed assets are $ 1 million, the company has no operating current liabilities. Earnings are expected to be 12% before interest and taxes, on sales of $ 2 million. The marginal tax rate is 30%, the interest rate is 8% on all debt and a 0.40 leverage ratio should be maintained. 

Three alternatives regarding the projected current asset level are available:

1. An aggressive policy, requiring current assets of only 40% of projected sales
2. A moderate policy of 50% of sales in current assets
3. A conservative policy, requiring current assets of 60% of sales.

Questions:

1. 1) What is the expected return on equity under each asset policy?
2. 2) Explain how would the overall riskiness of the company differ under each policy?

Answer rating: 100% (QA)

To calculate the expected return on equity ROE under each asset policy we need to calculate the amount of debt and equity financing under each policy ... View the full answer