RETURN ON EQUITY AND QUICK RATIO Lloyd Inc. has sales of $400,000, a net income
ID: 2816144 • Letter: R
Question
RETURN ON EQUITY AND QUICK RATIO Lloyd Inc. has sales of $400,000, a net income of $36,000, and the following balance sheet: Cash Receivables Inventories Total current assets Net fixed assets Total assets The new owner thinks that inventories are excessive and can be lowered to the point where the current ratio is equal to the industry average, 1.75x, without affecting sales or net income a. If inventories are sold and not replaced (thus reducing the current ratio to 1.75x); if the funds generated are used to reduce common equity (stock can be $70,040 Accounts payable 100,640 Notes payable to bank 312,800 Ttal current liabilities $80,920 42,840 $123,760 121,720 434,520 $680,000 $483,480 Long-term debt 196,520 Common equity $680,000 Total liabilities and equity repurchased at book value); and if no other changes occur, by how much will the ROE change? Do not round intermediate calculations. Round your answer to two decimal places 9.81 b. What will be the firm's new quick ratio? Do not round intermediate calculations. Round your answer to two decimal places 1.38Explanation / Answer
Current Ratio at the beginning = 483480/123760
= 3.91
Current ratio now = 1.75
Considering new inventory = x
(Cash + Receivables+x)/123760 = 1.75
70040+100640+x = 1.75*123760
x = 45900
Inventory needs to be reduced by 266900 ( 312800 - 45900)
Repurchasing the stock at book value, common equity reduces by 266900.
New Common Equity = 434520 - 266900
= 167620
ROE before repurchase of share = Net Income/434520
= 36000/434520
= 8.29%
ROE after repurchase of share = Net Income/167620
= 21.48%
ROE will change by = 21.48% - 8.29%
= 13.19% Answer
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