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The Texas State Company is attempting to establish a current assets policy. Fixed assets are $600,000, and the firm plans to maintain a 40 percent debt-to-assets ratio. Calgary has no operating current liabilities. The interest rate is 12 percent on all debt. Three alternative current asset policies are under consideration: 40, 50, and 60 percent of projected sales. The company expects to earn 18 percent before interest and taxes on sales of $6 million. Calgary's effective tax rate is 40 percent.
1. What is the expected return on equity under each alternative?
2. Evaluate ROE from owner point of view and suggest which option is best for him?
3. Suggest which option would you like if you are managers of the company and do not have much concern about business?
4. Why current assets policy is important in this particular situation?
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