Callison Airlines is deciding whether to pursue a restricted or relaxed working capital investment policy. Callison's annual sales are expected to total $3.6 million, its fixed assets turnover ratio equals 4.0, and its debt and common equity are each 50 percent of total assets. EBIT is $150,000, the interest rate on the firm's debt is 10 percent, and the firm's tax rate is 40 percent. If the company follows a restricted policy, its total assets turnover will be 2.5.
Under a relaxed policy, its total assets turnover will be 2.2.
-If the firm adopts a restricted policy, how much will it save in interest expense (relative to what it would be if Callison were to adopt a relaxed policy)?
A) $ 3,233
B) $ 6,175
C) $ 9,818
D) $ 7,200
E) $10,136

Question

Quizplus · Accepted Answer

Under a restricted policy, the total assets turnover is higher, meaning fewer assets are needed for the same sales level. This results in lower total assets and, consequently, less debt. The interest expense savings is calculated based on the difference in debt levels between the two policies.

Callison Airlines Is Deciding Whether to Pursue a Restricted or Relaxed