Scott Equipment Organization is investigating various combinations of short and long-term debt in financing assets. Assume the organization has decided to employ $30 million in current assets and $35 million in fixed assets in its operations next year, provided the level of current assets, anticipated sales, and EBIT for next year are $60 million and $6 million, respectively. The organization's income tax rate is 40%. Stockholders' equity will be used to finance $40 million of assets, with the remainder financed by short and long-term debt. The organization is considering implementing one of the policies in the diagram below.
Amount of Short-Term Debt
Financial Policy In mil. LTD (%) STD (%)
Aggressive $24 8.5 5.5
(large amount of short-term debt)
Moderate $18 8.0 5.0
(moderate amount of short-term debt)
Conservative $12 7.5 4.5
(small amount of short-term debt)
A. Determine the following for each policy:
• Expected rate of return on stockholders' equity
• Net working capital position
• Current ratio
B. Paper:
• Write a 1,400 to 1,750 word paper in which you evaluate profitability versus risk trade-offs of these policies. Would you rate them low, medium, or high with regard to profitability? Would you rate them low, medium, or high with regard to risk?