Michaela Wall

April 5, 2018
Case #29

Office Mates, Inc. has paid more attention to their manufacturing and marketing areas and have put financial
management after these. To rectify this situation a new working capital policy will be made. This will be accomplished by
creating pro forma income statements, creating scenarios for these working capital policies, calculating basic earning
power, and calculating the return on equity under each policy. The three scenarios used will be an aggressive policy, a
moderate policy, and a conservative policy. These three policies will each be used to calculate the basic earning power
and return on equity for an average economy, a weak economy, and a strong economy.

In an average economy, the expected return on equity for the firm would be 20.67% for an aggressive policy,
17.10% for a moderate policy, and 14.02% for a conservative policy. If the firm is, operating in a weak economy the
return on equity under an aggressive policy would be 0.67%, under a moderate policy, it would be 5.10%, and under a
conservative policy, it would be 8.56%. If the firm were operating in a strong economy, the return on equity under an
aggressive policy would be 27.33%, 26.10% under a moderate policy, and 24.93% under a conservative policy. These
calculations are shown graphically below in Figure 1-3.

In an average economy, the expected basic

earning power for the firm would be 22.22% for an
aggressive policy, 20% for a moderate policy, and
18.18% for a conservative policy. If the firm is, operating
in a weak economy the expected basic earning power
under an aggressive policy would be 5.56%, 10% under
a moderate policy, and 13.64% under a conservative
policy. If the firm were operating in a strong economy,
the basic earning power of the firm under an aggressive
Figure 1 policy would be 27.78%, 27.50% under a moderate
policy, and 27.27% under a conservative policy. These
numbers are compared graphically in Figure 4-6.

Looking at the return on equity calculations

alone, an aggressive policy in a strong economy would
give the best results for the firm. The only time an
aggressive policy would not be a good choice would be
in a weak economy. If an aggressive policy is used the
minimum amount of cash and inventory could lead to
problems paying debt and unfilled orders. Based on
these scenarios the only time a conservative policy
would be the most benefitial would be when the
Figure 2
economy is weak. Choosing a conservative policy would
make the company more liquid but less profitable.

In an average economy, if the debt cost for

short-term debt was increased to 15% the return on
equity would decrease to 17.67% under the aggressive
policy. This change would not change the return on
equity under the moderate or conservative policies.
This shows that debt has a big impact on the return on
equity.

Figure 3
 Michaela Wall
April 5, 2018
Office Mates, Inc. has a supplier which furnishes them
with $500,000 of materials a year and offers 3/10 net 60. The
Figure 5
net daily purchases from this supplier are $1,347.22 looking at
a 360-day year. The firm’s average level of accounts payable to
this supplier if the discount is taken would be 3.09% and
without the discount, it would be 22.27%. The dollar amounts
of free credit and costly credit would be $515,450 and
$611,350.

Based off all these calculations, if the firm is in an

average economy the most beneficial policy would be the
Figure 4 aggressive policy with lower sales and a higher net income. In a
weak economy, the conservative policy would be the most
beneficial with higher sales and a higher net income. In a
strong economy, the aggressive policy would be the most
beneficial for the firm with lower sales and a lower net income.

Figure 5

Figure 4