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 Expected EBIT (in Millions (in Millions Interest Rate Policy of Dollars) of Dollars) STD (%) LTD (%) Aggressive $98 $9.8 9.1 10.1 Moderate 99 9.9 8.1 8.6 Conservative 100 10.0 7.1 7.1 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. Policy Aggressive Moderate Conservative Expected Rate of Return on Common Equity % % %

Principles of Accounting Volume 2

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ISBN:9781947172609

Author:OpenStax

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Chapter9: Responsibility Accounting And Decentralization

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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	Expected EBIT
	(in Millions	(in Millions	Interest Rate
Policy	of Dollars)	of Dollars)	STD (%)	LTD (%)

Aggressive	$98		$9.8	9.1	10.1
Moderate	99		9.9	8.1	8.6
Conservative	100		10.0	7.1	7.1

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.

	Policy
	Aggressive	Moderate	Conservative

Expected Rate of Return on Common Equity	%	%	%

Alternative Working Capital Investment and Financing Policies for Burlington Resources
(in Millions of Dollars)
Aggressive
Moderate
Conservative
Relatively Large
Relatively Small
Investment in
Moderate
Investment in
Investment in
Current Assets;
Relatively Large
Amount of
Current Assets;
Moderate
Current Assets;
Relatively Small
Amount of
Amount of
Short-Term Debt
Short-Term Debt
Short-Term Debt
$ 35
$ 40
$ 45
30
$ 75
$ 10
Current assets (C/A)
Fixed assets (F/A)
30
30
$ 65
$ 30
$ 70
$ 20
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
22
35
$ 39
$ 42
$ 45
26
$ 65
28
$ 70
30
$ 75
Forecasted sales
$100
$100
$100
Expected EBIT
10
10
10
Less Interest
STD, 8%
LTD, 10%
2.4
1.6
0.8
3.3
$ 6.7
2.7
$ 4.0
2.2
4.3
$ 5.7
0.9
3.8
$ 6.2
3.5
Taxable income
Less Taxes (40%)
2.5
$ 3.7
2.3
Net income after taxes
$3.4
Expected rate of return on common equity
Net working capital position (C/A - C/L)
Current ratio (C/A + C/L)
15.4%
13.2%
11.3%
$5
$20
$35
1.17
2.0
4.5

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