Exhibit 15.1 Zorn Corporation is deciding
whether to pursue a restricted or relaxed working capital
investment policy. The firm’s annual sales are expected to total
$4,400,000, its fixed assets turnover ratio equals 4.0, and its
debt and common equity are each 50% of total assets. EBIT is
$150,000, the interest rate on the firm’s debt is 10%, and the tax
rate is 40%. If the company follows a restricted policy, its total
assets turnover will be 2.5. Under a relaxed policy its total
assets turnover will be 2.2.
Refer to Exhibit 15.1. Assume now that the company believes that if
it adopts a restricted policy, its sales will fall by 15% and EBIT
will fall by 10%, but its total assets turnover, debt ratio,
interest rate, and tax rate will all remain the same. In this
situation, what’s the difference between the projected ROEs under
the restricted and relaxed policies?
