OClick here to read the eblook: Profitability Ratios Problem Walk-Through RETURN

Question

OClick here to read the eblook: Profitability Ratios Problem Walk-Through RETURN ON EQUITY Pacific Packaging's ROE last year was only 4%; but its management has developed a new operating plan that calls for a debt to capital ratio of 55% which will result in annual interest charges of S 700 000 The firm has no plans to use preferred stock and total assets equal total invested capital, Management projects an EBIT of $1,232,000 on sales of $14,000,000, and it expects to have a total assets turnover ratio of 1.5. Under these conditions, the tax rate will be 40%. If the changes are made, what will be the company's return on equity? Do not round intermediate calculations. Round your answer to two decimal places

Explanation / Answer

Step 1: Calculation of Net Income

Step 2: Calculation of Total assets

Total assets turnover ratio can be calculated as

Net Sales / Total Assets

14,000,000 / Total Assets = 1.5

Total Assets = 14,000,000/1.5

= 9,333,333.33

In question it says that total assets = total invested capital

Step 3: Calculation of Shareholder's Equity

Debt to Capital Ratio = Debt / Total Capital

.55 = Debt / 9,333,333.33

Debt = 9,333,333.33*.55

= 5,133,333.33

Shareholder's Equity = Total Capital - Debt

= 9,333,333.33 - 5,133,333.33

= 4,200,000

Step 4: Calculation of Return On Equity(ROE)

ROE = Net Income/Shareholder's Equity

= 319,200 / 4,200,000

= .076

= 7.60%

$ EBIT 1,232,000 Less: Interest           700,000 Income Before Income Tax (EBT)           532,000 Less: Income Tax@40%           212,800 Net Income           319,200

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