Answer:
6.56%
Explanation:
1. Restricted policy where current assets are 15% of sales.
Sales = $400,000
Current assets = 0.15 * 400000 = $60,000
Total assets = Fix assets + Current assets = 100,000 + 60,000 = $160,000
Debt accounts for 50% of capital structure. Therefore 50% assets will be financed through debt.
Debt = 0.5 *160,000 = $80,000
Equity = Assets - Debt =$80,000
Interest on Debt = 10% * $80,000 = $8,000
EBIT = $35,000
Profit before tax = 35000 - 8000 = 27000
Tax = 25% of 27,000 = $6,750
PAT = $27,000-$6,750
= $20,250
ROE = 20,250/ 80000 = 25.31%
2. Calculations for relaxed policy where current assets are 25% of sales.
Sales = $400,000
Current assets = 0.25 * 400000 = $100,000
Total assets = Fix assets + Current assets = 100,000 + 100,000 = $200,000
Debt accounts for 50% of capital structure. Therefore 50% assets will be financed through debt.
Debt = 0.5 *200,000 = $100,000
Equity = Assets - Debt =$100,000
Interest on Debt = 10% * $100,000 = $10,000
EBIT = $35,000
Profit before tax = 35000 - 10000 = 25000
Tax = 25% of 25,000 = $6,250
PAT = 25000 - 6,250 = $18,750
ROE = 18750/ 100000 = 18.75%
The difference between the 2 ROEs = 25.31% - 18.75% = 6.56%
Therefore the difference in the projected ROEs between the restricted and relaxed policies is 6.56%
