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
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Income Statement
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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...