Buchholz Corporation follows a moderate current asset investment policy,but it is now considering a change,perhaps to a restricted or maybe to a relaxed policy.The firm's annual sales are $400,000;its fixed assets are $100,000;its target capital structure calls for 50% debt and 50% equity;its EBIT is $35,000;the interest rate on its debt is 10%;and its tax rate is 40%.With a restricted policy,current assets will be 15% of sales,while under a relaxed policy they will be 25% of sales.What is the difference in the projected ROEs between the restricted and relaxed policies?
A) 4.25%
B) 4.73%
C) 5.25%
D) 5.78%
E) 6.35%

Question

Quizplus · Accepted Answer

The difference in ROE is calculated by determining the net income and equity under both policies and then finding the difference in ROE. Under the restricted policy, current assets are lower, leading to higher asset turnover and potentially higher ROE. Under the relaxed policy, current assets are higher, leading to lower asset turnover and potentially lower ROE. The calculations show a difference of 5.25% in ROE between the two policies.

Buchholz Corporation Follows a Moderate Current Asset Investment Policy,but It