Problem-22.

4
Solution:

Effects of Alternative Financial Policies

Explanation Conservative Moderate Aggressive

1. Current Assets 3.90 3.90 3.90
2. Fixed Assets 2.60 2.60 2.60
3. Total Assets 6.50 6.50 6.50
4. Current Liabilities 2.34 2.34 2.34
5. Short-term debt 0.54 1.00 1.50
6. Long-term debt 1.12 0.66 0.16
7. Equity Capital 2.50 2.50 2.50
8. Total Capital (4+5+6+7) 6.50 6.50 6.50
9. Forecasted Sales 11.50 11.50 11.50
10. Expected EBIT 1.15 1.15 1.15
11. Interest for STD 0.06 0.12 0.18
Interest for LTD 0.18 0.11 0.03
12. Profit before tax (10-11) 0.91 0.92 0.94
13. Tax (35%) 0.32 0.32 0.33
14. Profit After tax (12-13) 0.59 0.60 0.61
a) Return on Equity (14/7) 23.6% 24.0% 24.6%
b) Net WC position (1-4+5) 1.02 0.56 0.06
c) Current Ratio (1/4+5) 1.35 1.17 1.02
In this math, we can see that return on shareholder’s equity is minimum under the
conservative policy. On the other hand, ROE is the highest under the aggressive
policy. If a company wants to increase its profitability then they should reduce
investment in working capital, but this policy bears more risks.