Savelots Stores\' current financial statements are shown below: Inventories $ 50
ID: 2702695 • Letter: S
Question
Savelots Stores' current financial statements are shown below: Inventories $ 500 Accounts payable $ 100 Other current assets 400 Short-term notes payable 370 Fixed assets 370 Common equity 800 Total assets $1,270 Total liab. and equity $1,270 Sales $2,000 Operating costs 1,843 EBIT 157 Less: Interest 37 EBT 120 Less: Taxes (40%) 48 Net income 72 A recently released report indicates that Savelots' current ratio of 1.9 is in line with the industry average. However, its accounts payable, which have no interest cost and which are due entirely to purchases of inventories, amount to only 20% of inventory versus an industry average of 60%. Suppose Savelots took actions to increase its accounts payable to inventories ratio to the 60% industry average, but it (1) kept all of its assets at their present levels (that is, the asset side of the balance sheet remains constant) and (2) also held its current ratio constant at 1.9. Assume that Savelots' tax rate is 40%, that its cost of short-term debt is 10%, and that the change in payments will not affect operations. In addition, common equity would not change. With the changes, what would be Savelots' new ROE? A) 9.0% B) 10.5% C) 13.2% D) 7.8% E) 12.0%Explanation / Answer
Savelots Stores' current financial statements are shown below:
Inventories $ 500 Accounts payable $ 100
Other current assets 400 Short-term notes payable 370
Fixed assets 370 Common equity 800
Total assets $1,270 Total liab. and equity $1,270
Sales $2,000
Operating costs 1,843
EBIT 157
Less: Interest 37
EBT 120
Less: Taxes (40%) 48
Net income 72
A recently released report indicates that Savelots' current ratio of 1.9 is in line with the industry average. However, its accounts payable, which have no interest cost and which are due entirely to purchases of inventories, amount to only 20% of inventory versus an industry average of 60%. Suppose Savelots took actions to increase its accounts payable to inventories ratio to the 60% industry average, but it (1) kept all of its assets at their present levels (that is, the asset side of the balance sheet remains constant) and (2) also held its current ratio constant at 1.9. Assume that Savelots' tax rate is 40%, that its cost of short-term debt is 10%, and that the change in payments will not affect operations. In addition, common equity would not change. With the changes, what would be Savelots' new ROE?
The only changes that take place are:
1. 1. Accounts Payable increase to $300 (60% of Inventory)
2. 2. Short-term Notes Payable decrease to $170 (to offset the $200 increase in accounts payable and keep current liabilities constant)
3. 3. As a result of the above, the income statement changes as follows:
Sales $2,000
Operating costs 1,843
EBIT 157
Less: Interest 17 (10% x $170)
EBT 140
Less: Taxes (40%) 56
Net income 84
4. ROE = 84/800 = .105 = 10.5%
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.