Reference no: EM133018705

Question - Payne Products sales last year were an anaemic €1.6million, but with an improved product mix it expects sales growth to be 25 per cent this year, and Payne would like to determine the effect of various current assets policies on its financial performance. Payne has €1 million of fixed assets and intends to keep its debt ratio at its historical level of 60 per cent. Payne's debt interest rate is currently 8 per cent. You are to evaluate three different current asset policies (1) a tight policy in which current assets are 45 per cent of projected sales, (2) a moderate policy with 50 per cent of sales tied up in current assets, and (3) a relaxed policy requiring current assets of 60 per cent of sales. Earnings before interest and taxes are expected to be 12 per cent of sales. Payne's tax rate is 40 per cent.

a. What is the expected ROE under each current asset level?

b. In this problem, we have assumed that the level of expected sales is independent of the current asset policy. Is this a valid assumption? Why, or why not?

c. How would the overall riskiness of the firm vary under each policy?