Hardwig Inc.
Hardwig Inc.is considering whether to pursue a restricted or relaxed current asset investment policy.The firm's annual sales are expected to total $3,600,000, its fixed assets turnover ratio equals 4.0, and its debt and common equity are each 50% of total assets.EBIT is $150,000, the interest rate on the firm's debt is 10%, and the tax rate is 25%.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.
-Refer to the data for Hardwig, Inc.Assume now that the company believes that if it adopts a restricted policy, its sales will fall by 15% and EBIT will fall by 10%, but its total assets turnover, debt ratio, interest rate, and tax rate will all remain the same.In this situation, what's the difference between the projected ROEs under the restricted and relaxed policies?

Question

Quizplus · Accepted Answer

Under the restricted policy, sales will fall by 15% and EBIT will fall by 10%. This will lead to a decrease in ROE. The relaxed policy will not have this effect, so the difference between the projected ROEs under the restricted and relaxed policies will be greater than under the original scenario.

Hardwig Inc. Hardwig Inc.is Considering Whether to Pursue a Restricted or Relaxed