The New Scott Equipment Organization Paper

Essay by arualUniversity, Bachelor'sA+, January 2011

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The New Scott Equipment Organization Paper

FIN/419: Finance for Decision Makers

Scott Equipment Organization is investigating the use of various combinations of short-term and long-term debt in financing its assets. The organization has decided to employ $25 million in current assets, along with $40 million in fixed assets, in its operations next year. Anticipated sales and Earnings Before Interest and Taxes (EBIT) for next year are $60 million and $6 million, respectively. The organization's income tax rate is 40%; stockholders' equity will be used to finance $40 million of its assets, with the remainder being financed by short-term and long-term debt. Scott's is considering implementing one of the following financing policies:

Amount of Short-Term Debt

Financial Policy

In millions

LTD

(%)

STD

(%)

Aggressive

(large amount of short-term debt)

$20

8.5

5.5

Moderate

(moderate amount of short-term debt)

$15

8.0

5.0

Conservative

(small amount of short-term debt)

$10

7.5

4.5

Based on the above information, the following calculations were determined.

Balance Sheet

Table/chart/diagram/image is missing. Please download the Word document to view it.

Income Statement

Table/chart/diagram/image is missing. Please download the Word document to view it.

Expected Rate of Return on Stockholders' Equity

ROE (Return on Common Equity) = EAT (earnings after taxes) / Equity

Aggressive

Interest = ($20,000,000 x .055) + ($5,000,000 x .085) = $1,525,000

EBT = EBIT - interest = $6,000,000 - 1,525,000 = $4,475,000

Taxes = EBT x 40% = $4,475,000 x .40 = $1,790,000

EAT = EBT - taxes = $4,475,000 - 1,790,000 = $2,685,000

ROE = EAT / equity = $2,685,000 / 40,000,000 = 6.71%

Moderate

Interest = ($15,000,000 x .05) + ($10,000,000 x .08) = $1,550,000

EBT = EBIT - interest = $6,000,000 - 1,550,000 = $4,450,000

Taxes = EBT x 40% = $4,450,000 x .40 = $1,780,000

EAT = EBT...