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. Amount of Short-Term Debt
Financial Policy Millions of dollars LTD (%) STD (%) Aggressive (large amount of short-term debt) $24 8.5 5.5 Moderate (moderate amount of short-term debt) $18 8.0 5.0 Conservative (small amount of short-term debt) $12 7.5 4.5
Determine the following for each policy: • Expected rate of return on stockholders’ equity • Net working capital position • Current ratio 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 respect to profitability? Would you rate them low, medium, or high with respect to risk?