Scott Equipment Organization is trying to determine between short- and long-term debt for its operations next year. The company wants to examine three different scenarios to determine the rate of return on equity, the net working capital position and the current ratio that each of the options will deliver. The different scenarios are as follows.
Aggressive
$24 million STD
LTD 8.5%
Moderate
$18 million STD
LTD 8%
Conservative
$12 million STD
LTD 7.5%
This paper will analyze these different scenarios to determine the effect that each will have on the company's finances. The givens in the scenario are $30 million in current assets, $35 in long-term assets, $40 million in equity, sales of $60 million, EBIT of $6 million and a tax rate of 40%. The paper will not only analyze the three financial metrics but will examine the three scenarios in terms of the tradeoffs that they offer.
Return on Equity
For the three scenarios, the return on equity calculations are as follows:
Scenarios
Aggressive
Moderate
Conservative
STD $
STD %
0.96
0.72
0.48
Rate LTD
8.50%
8%
7.50%
Rate STD
5.50%
5%
4.50%
WA %
0.0562
0.0584
0.0606
Interest
1405000
1460000
1515000
EBIT-Int
4595000
4540000
4485000
Tax
1838000
1816000
1794000
Net Income
2757000
2724000
2691000
ROE
6.89%
6.81%
6.73%
These figures shows that there is little difference between the three scenarios with respect to ROE. Part of the reason is that while the more conservative scenarios have lower rates, they also have higher proportions of long-term interest, which comes at a higher rate. Thus, the two movements offset each other somewhat, and the net interest rate does not change too much between the scenarios. The conservative approach does deliver the lowest ROE, while the more aggressive approach...
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