Scott Equipment Organization

Scott Equipment Organization is
investigating various combinations of short- and long-term debt in financing
assets. Assume the organization has decided to employ $10 million in current
assets and $15 million in fixed assets in its operations next year, and EBIT
for next year is $8 million. The organization’s income tax rate is 40%.
Stockholders’ equity will be used to finance $15 million of assets, with the
remainder financed by short- and long-term debt. The organization is
considering implementing one of the policies below.
Current Assets: $10 million
Fixed Assets: $15 million
Total Assets : $25 million
Stockholders’ Equity: $15 million
Total Amount of Assets to be financed by debt: $10 million
Tax Rate: 40%
Total EBIT: $8 million
Aggressive Strategy
Short Term Debt: $8 million, 6% interest rate
Long Term Debt: $2 million, 8% interest rate
Moderate Strategy
Short Term Debt: $5 million, 5.5% interest rate
Long Term Debt: $5 million,7.5% interest rate
Conservative Strategy
Short Term Debt: $3 million, 5.25% interest rate
Long Term Debt: $7 million, 7.25% interest rate
Determine the following for each policy:
Net Income
Expected rate of return on stockholders’ equity (Net Income/Equity)
Net working capital position (Current Assets – Current Liabilities)
Current ratio (Current Assets/Current Liabilities)
Would you rate them low, medium, or high with respect to profitability?
Would you rate them low, medium, or high with respect to risk?
What is your recommendation to management? Why?