You are considering investing in Dakota’s Security Services. You have been able
ID: 2651042 • Letter: Y
Question
You are considering investing in Dakota’s Security Services. You have been able to locate the following information on the firm: Total assets are $32.5 million, accounts receivable are $4.45 million, ACP is 25 days, net income is $4.00 million, and debt-to-equity is 1.2 times. All sales are on credit. Dakota’s is considering loosening its credit policy such that ACP will increase to 30 days. The change is expected to increase credit sales by 5 percent. Any change in accounts receivable will be offset with a change in debt. No other balance sheet changes are expected. Dakota’s profit margin will remain unchanged.
How will this change in accounts receivable policy affect Dakota’s net income, total asset turnover, equity multiplier, ROA, and ROE?
You are considering investing in Dakota’s Security Services. You have been able to locate the following information on the firm: Total assets are $32.5 million, accounts receivable are $4.45 million, ACP is 25 days, net income is $4.00 million, and debt-to-equity is 1.2 times. All sales are on credit. Dakota’s is considering loosening its credit policy such that ACP will increase to 30 days. The change is expected to increase credit sales by 5 percent. Any change in accounts receivable will be offset with a change in debt. No other balance sheet changes are expected. Dakota’s profit margin will remain unchanged.
Explanation / Answer
Answer:
Current
After Change
Total assets
$ 32,500,000
$ 33,657,000
(32500000+5607000-4450000)
Accounts receivable
$ 4,450,000
$ 5,607,000
(Sales*ACP /365)
(68218500*30/365)
ACP (Days)
25
30
Net income
$ 4,000,000
$ 4,200,000
Sales * Profit Margin
(68218500*6.16%)
Debt-to-equity
1.20
Debt
$ 17,727,273
$ 18,884,273
(32500000*1.2 /2.2)
(17727273+5607000-4450000)
Equity
$ 14,772,727
$ 14,772,727
(Total assets - Debt )
Equity Multiplier
2.20
2.28
(Total Assets / Equity)
Sales
$ 64,970,000
$ 68,218,500
(Accounts Rec *365 /ACP)
(4450000*365 /25)
(64970000*105%)
Profit Margin
6.16%
6.16%
(Net Profit / Sales)
(4000000 /64970000)
Unchanged
Total Assets Turnover
2.00
2.03
(Sales / Total Assets)
ROA
12.31%
12.48%
(Net Income / Total Assets)
ROE
27.08%
28.43%
(Profit Maring *Assets Turnover* Equity Multiplier)
Current
After Change
Total assets
$ 32,500,000
$ 33,657,000
(32500000+5607000-4450000)
Accounts receivable
$ 4,450,000
$ 5,607,000
(Sales*ACP /365)
(68218500*30/365)
ACP (Days)
25
30
Net income
$ 4,000,000
$ 4,200,000
Sales * Profit Margin
(68218500*6.16%)
Debt-to-equity
1.20
Debt
$ 17,727,273
$ 18,884,273
(32500000*1.2 /2.2)
(17727273+5607000-4450000)
Equity
$ 14,772,727
$ 14,772,727
(Total assets - Debt )
Equity Multiplier
2.20
2.28
(Total Assets / Equity)
Sales
$ 64,970,000
$ 68,218,500
(Accounts Rec *365 /ACP)
(4450000*365 /25)
(64970000*105%)
Profit Margin
6.16%
6.16%
(Net Profit / Sales)
(4000000 /64970000)
Unchanged
Total Assets Turnover
2.00
2.03
(Sales / Total Assets)
ROA
12.31%
12.48%
(Net Income / Total Assets)
ROE
27.08%
28.43%
(Profit Maring *Assets Turnover* Equity Multiplier)
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