Last year, K9 WebbWear, Inc., reported an ROE of 20 percent. The firm’s debt rat
ID: 2813665 • Letter: L
Question
Last year, K9 WebbWear, Inc., reported an ROE of 20 percent. The firm’s debt ratio was 60 percent, sales were $25 million, and the capital intensity was 1.20 times. This year, K9 WebbWear plans to increase its debt ratio to 70 percent. The change will not affect sales or total assets, however, it will reduce the firm’s profit margin to 9 percent. Calculate the net income and profit margin for K9 WebbWear last year. (Enter your answer in millions of dollars rounded to 2 decimal places. Round your percentage answer to 2 decimal places.) Net income (Last year) $ million Profit margin (Last year) % By how much will the change in K9 WebbWear’s debt ratio affect its ROE? Change in ROE (This year) %
Explanation / Answer
Computation of Last year's Net income and Profit margin
Total Assets = Capital intensity * Sales
Total Assets = 1.20 * $25 Million = $30 Million
Total Debt = Debt ratio * Total Assets = 0.60 * $30 Million = $18 Million
Total equity = total assets - Total debt = $30 Million - $18 Million = $12 Million
Net Income = ROE * Total Equity = $12 Million * 20% = $2.4 Million
Profit Margin = Net Income / Sales = $2.4 Million / $25 Million = 9.60%
This Year ROE Change because of debt ratio change:
Net Income = Sales * Profit Margin = $25 Million * 9% = $2.25 Million
Total Equity = Total Assets - Total Debt
Total Equity = $30 Million - $30 Million * 70%
Total Equity = $9 Million
ROE = Net Ibncome / Total Equity = $2.25 Million / $9 Million
ROE = 25%
Debt change effect on ROE is 5%
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