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# The New Scott Equipment Organization Paper

835 words - 3 pages

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

Income Statement

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 - taxes = \$4,450,000 - 1,780,000 = \$2,670,000

ROE = EAT / equity = \$2,685,000...

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