Pacific Packaging\'s ROE last year was only 6%; but its management has developed
ID: 2817783 • Letter: P
Question
Pacific Packaging's ROE last year was only 6%; but its management has developed a new operating plan that calls for a debt-to-capital ratio of 60%, which will result in annual interest charges of $350,000. The firm has no plans to use preferred stock and total assets equal total invested capital. Management projects an EBIT of $672,000 on sales of $7,000,000, and it expects to have a total assets turnover ratio of 1.6. Under these conditions, the tax rate will be 35%. 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
Total Asset Turnover ratio = Sales/ Total assets = 7,000,000/Total Assets = 1.6
Total Assets = 7,000,000/1.6 = 4,375,000
Debt to Capital ratio = 60%
Debt = 60%*4375000 = 2625000
Equity = 40% * 4375000 = 1,750,000
Net income = (EBIT - Interest)*(1-tax rate) = (672000 - 350,000)*(1-35%) = 209,300
Equity = 1,750,000
ROE = Net Profit/Equity = 209,300/1,750,000 = 0.1196 or 11.96%
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