Question

1. A company has $1,000,000 of fixed assets (or long-term assets) and requires its total debt to be 40% of its total assets. Two alternative working capital policies are as follows: alternative A calls for $800,000 of current assets and $100,000 of short-term debt, while alternative B calls for $400,000 of current assets and $500,000 of short-term debt. The interest rate on short-term debt is 8%, whereas the interest rate on long-term debt is 10%. The firm's tax rate is 30%. Earnings before interest and taxes are expected to be $400,000. Calculate the current ratio and the ROE for both alternatives A and B. Which of the two alternatives (A or B) will be selected by an aggressive financial manager?