Problem:

Working Capital Policy

Payne Products's sales last year were an anemic $1.6 million, but with an improved product mix it expects sales growth to be 25% this year, and Payne would like to determine the effect of various current assets policies on its financial performance. Payne has $3 million of fixed assets and intends to keep its debt ratio at its historical level of 40%. Payne's debt interest rate is currently 8%. You are to evaluate three different current asset policies: (1) a tight policy in which current assets are 45% of projected sales, (2) a moderate policy with 50% of sales tied up in current assets, and (3) a relaxed policy requiring current assets of 60% of sales. Earnings before interest and taxes is expected to be 13% of sales. Payne's tax rate is 35%.

Task:

Question: What is the expected return on equity under each current asset level? Round your answers to two decimal places.

• Tight policy %
• Moderate policy %
• Relaxed policy %

Note: Please provide equation and explain comprehensively and give step by step solution.