Consider the comprehensive example involving Burlington Resources (Table 16.5). In this example, it was assumed that forecasted sales and expected EBIT, as well as the interest rates on short-term and long-term debt, were independent of the firm's working capital investment and financing policies. However, these assumptions are not always completely realistic in practice. Sales and EBIT are generally a function of the firm's inventory and receivables policies. Both of these policies, in turn, affect the firm's level of investment in working capital. Likewise, the interest rates on short-term and long-term debt are normally a function of the riskiness of the firm's debt as perceived by lenders and, hence, are affected by the firm's working capital investment and financing decisions. Policy Aggressive Moderate Conservative Forecasted Sales (in Millions of Dollars) $98 99 100 Expected EBIT (in Millions of Dollars) $9.8 9.9 10.0 Expected Rate of Return on Common Equity Interest Rate LTD (%) 10.3 8.9 7.5 Aggressive STD (%) Recompute Burlington's rate of return on common equity under the set of assumptions concerning sales, EBIT, and interest rates for each of the three different working capital investment and financing policies provided in the table above. Round your answers to two decimal places. 9.3 8.1 6.9 % Policy Moderate % Conservative %
Consider the comprehensive example involving Burlington Resources (Table 16.5). In this example, it was assumed that forecasted sales and expected EBIT, as well as the interest rates on short-term and long-term debt, were independent of the firm's working capital investment and financing policies. However, these assumptions are not always completely realistic in practice. Sales and EBIT are generally a function of the firm's inventory and receivables policies. Both of these policies, in turn, affect the firm's level of investment in working capital. Likewise, the interest rates on short-term and long-term debt are normally a function of the riskiness of the firm's debt as perceived by lenders and, hence, are affected by the firm's working capital investment and financing decisions. Policy Aggressive Moderate Conservative Forecasted Sales (in Millions of Dollars) $98 99 100 Expected EBIT (in Millions of Dollars) $9.8 9.9 10.0 Expected Rate of Return on Common Equity Interest Rate LTD (%) 10.3 8.9 7.5 Aggressive STD (%) Recompute Burlington's rate of return on common equity under the set of assumptions concerning sales, EBIT, and interest rates for each of the three different working capital investment and financing policies provided in the table above. Round your answers to two decimal places. 9.3 8.1 6.9 % Policy Moderate % Conservative %
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:Consider the comprehensive example involving Burlington Resources (Table 16.5). In this example, it was assumed that forecasted sales and expected EBIT, as well as the interest rates on short-term and long-term debt, were
independent of the firm's working capital investment and financing policies. However, these assumptions are not always completely realistic in practice. Sales and EBIT are generally a function of the firm's inventory and receivables
policies. Both of these policies, in turn, affect the firm's level of investment in working capital. Likewise, the interest rates on short-term and long-term debt are normally a function of the riskiness of the firm's debt as perceived by
lenders and, hence, are affected by the firm's working capital investment and financing decisions.
Forecasted Sales
Policy
Aggressive
Moderate
Conservative
Expected EBIT
(in Millions
of Dollars)
(%)
770
$9.8
9.9
10.0
(in Millions
of Dollars)
$98
99
100
Expected Rate of Return on Common Equity
Interest Rate
Aggressive
STD
9.3
8.1
6.9
LTD
%
(%)
10.3
Recompute Burlington's rate of return on common equity under the set of assumptions concerning sales, EBIT, and interest rates for each of the three different working capital investment and financing policies provided in the table
above. Round your answers to two decimal places.
8.9
7.5
Policy
Moderate
%
Conservative
%
Transcribed Image Text:Alternative Working Capital Investment and Financing Policies for Burlington Resources
(in Millions of Dollars)
Current assets (C/A)
Fixed assets (F/A)
Total assets (T/A)
Current liabilities (STD) (C/L) (interest rate, 8%)
Long-term liabilities (LTD) (interest rate, 10%)
Total liabilities (60% of T/A)
Common equity
Total liabilities and common equity
Forecasted sales
Expected EBIT
Less Interest:
STD, 8%
LTD, 10%
Taxable income
Less Taxes (40%)
Net income after taxes
Expected rate of return on common equity
Net working capital position (C/A - C/L)
Current ratio (C/A + C/L)
Aggressive
Relatively Small
Investment in
Current Assets;
Relatively Large
Amount of
Short-Term Debt
$ 35
2.4
0.9
$ 65
$30
9
$39
$ 65
$100
10
3.3
$6.7
2.7
$4.0
15.4%
$5
1.17
Moderate
Moderate
Investment in
Current Assets;
Moderate
Amount of
Short-Term Debt
1.6
2.2
}
$ 40
30
$70
$ 20
22
$42
28
$ 70
$100
10
3.8
$ 6.2
2.5
$ 3.7
13.2%
$20
2.0
Conservative
Relatively Large
Investment in
Current Assets;
Relatively Small
Amount of
Short-Term Debt
0.8
3.5
$45
30
$75
$ 10
35
$ 45
30
$75
$100
10
4.3
$5.7
23
$3.4
11.3%
$35
4.5
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