Hardwig Inc. is considering whether to pursue a restricted or relaxed current asset investment policy. The firm's annual sales are expected to total $3,600,000, its fixed assets turnover ratio equals 4.0, and its debt and common equity are each 50% of total assets. EBIT is $150,000, the interest rate on the firm's debt is 10%, and the tax rate is 25%. If the company follows a restricted policy, its total assets turnover will be 2.5. Under a relaxed policy its total assets turnover will be 2.2. Refer to the data for Hardwig, Inc. What's the difference in the projected ROEs under the restricted and relaxed policies

Question

Hugo Ward

Business

19 June, 21:36

Hardwig Inc. is considering whether to pursue a restricted or relaxed current asset investment policy. The firm's annual sales are expected to total $3,600,000, its fixed assets turnover ratio equals 4.0, and its debt and common equity are each 50% of total assets. EBIT is $150,000, the interest rate on the firm's debt is 10%, and the tax rate is 25%. If the company follows a restricted policy, its total assets turnover will be 2.5. Under a relaxed policy its total assets turnover will be 2.2. Refer to the data for Hardwig, Inc. What's the difference in the projected ROEs under the restricted and relaxed policies

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Pierce Gentry · Answer 1

1.88%

Explanation:

total annual sales = $3,600,000

EBIT = $150,000

net income = $150,000 x (1 - 25%) = $112,500

restricted policy:

asset turnover = 2.5

sales = $3,600,000

EBIT = $150,000

net income = $112,500

assets = $3,600,000 / 2.5 = $1,440,000

equity = $1,440,000 x 50% = $720,000

ROE = $112,500 / $720,000 = 15.63%

relaxed policy:

asset turnover = 2.2

sales = $3,600,000

EBIT = $150,000

net income = $112,500

assets = $3,600,000 / 2.2 = $1,636,364

equity = 50% x $1,636,364 = $818,182

ROE = $112,500 / $818,182 = 13.75%

difference between ROEs = 15.63% - 13.75% = 1.88%