SPO Corporation is contemplating the appropriate level of current assets. The decision to determine the appropriate level of current assets will be based on return on equity. SPO is considering two alternatives; current assets would be 50 percent of sales or current assets would be 25 percent of sales. SPO’s sales are $6 million dollars. SPO expects its EBIT to be $900,000. SPO’s fixed assets total $5 million. SPO has a 50 percent debt ratio. SPO pays 6 percent interest on its debt and SPO has a 25 percent tax rate.
Required:
a)Determine the return on equity for the two policies.
b)Which policy has more risk? Explain.
c)Explain which policy you would chose.