4. Jackson Co. initially has $100 million in assets and is financed 25% with deb

Question

4. Jackson Co. initially has $100 million in assets and is financed 25% with debt and 75% with equity. The company's total asset turnover is 2, the net profit margin is 10%, and Jackson's retention rate is 60%. Based on the firm's business cycle, what are the amounts of debt and equity on the balance sheet after one year of operation (assuming the firm wishes to maintain its 25/75 debt/equity mix)? a. debt $87M; equity $29M b. debt- $29M; equity $87M c. debt $27.7M; equity $83M d. debt $37M; equity $87M e. none of the above

Explanation / Answer

Total assets currently = $100 million

Since Debt / Equity = 25 / 75

Debt = $25 million

Equity = $75 million

Total asset turnover = Sales / Total assets

2 = Sales / $100 million

Sales = $200 million

Net profit margin = Net profit / Sales

10% = Net profit / $200 million

Net profit = $20 million

Retention rate = 60%, i.e. 60% of the profits are retained in the company

Thus, total retention of profits = 60% * $20 million = $12 million

Revised equity at the end of the year = Beginning equity balance + Retention of profits in the year

Revised equity at the end of the year = $75 million + $12 million

Revised equity at the end of the year = $87 million

To maintain a debt / equity of 25 / 75 company has to keep $29 million as debt

To check, debt / equity = $29 million / $87 million = 0.3333

Also, 25 / 75 = 0.3333

Correct answer - b

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