# The New Scott Equipment Organization Paper

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...